In Pre-Antitrust U.S. Banking, Networks (Clearinghouses) Arose; Collusion Was Checked by the Threat of Network Withdrawal

In the pre-antitrust U.S. banking industry, then, networks known as clearinghouses arose to reduce transactions costs and bolster reputations. “An essential feature of the banking industry was the endogenous development of the clearinghouse, a governing association of banks to which individual banks voluntarily abrogated certain rights and powers normally held by firms.” Membership requirements and monitoring enhanced the public’s trust in the redeemability of members’ bank notes and the overall soundness of their business practices. As Gorton and Mullineaux (1987) explain:

The clearinghouse required, for example, that member institutions satisfy an admissions test (based on certification of adequate capital), pay an admissions fee, and submit to periodic exams (audits) by the clearinghouse. Members who failed to satisfy [commercial-bank clearinghouse] regulations were subject to disciplinary actions (fines) and, for extreme violations, could be expelled. Expulsion from the clearinghouse was a clear negative signal concerning the quality of the bank’s liabilities. . . . 

An additional check against collusion was banks’ credible threat to withdraw from the network or refuse to join. As Dowd recounts:

A good example of banks “voting with their feet” even when the market could only support one clearinghouse is provided by the demise of the Suffolk system. The Suffolk system was a club managed by the Suffolk Bank of Boston, but some members found the club rules too constraining and there were complaints about the Suffolk’s highhanded attitude toward members. Discontent led to the founding of a rival, the Bank of Mutual Redemption (BMR), and when the latter opened in 1858 many of the Suffolk’s clients defected to it.

—Bryan Caplan and Edward P. Stringham, “Networks, Law, and the Paradox of Cooperation,” in Anarchy and the Law: The Political Economy of Choice, ed. Edward P. Stringham (New Brunswick, NJ: Transaction Publishers, 2007), 305-306.

Cowen Maintains that the Historical Evidence on Collusion under Laissez-Faire Cannot Be Extended to Network Industries

Cowen’s case is almost wholly theoretical. The usual historical evidence on collusion under laissez-faire, he maintains, cannot be credibly extended to network industries: “Although private cartels usually collapse of their own accord, most historical examples of cartel instability do not involve the benefits of joining a common network.” But Cowen provides little in the way of empirical counter-examples to support his belief that networks industries are different.

This section takes a preliminary look at modern and historical network industries. While they definitely standardize products in beneficial ways, there is little evidence that network industries are more prone to collusion than non-network industries. Instances of attempted and temporarily successful collusion do surface. But collusive efforts in network industries appear neither more common nor more successful than in other sectors of the economy. A full-blown comparative history of collusion in network and non-network industries is beyond the scope of this paper. On Cowen’s account, however, the contrast should be too large to miss. . . .

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The market for credit cards has all the defining characteristics of a network industry. The value of a credit card increases with the number of participating consumers, merchants, and banks. As Evans and Schmalensee (1999) observe, “[P]ayment cards are provided through a network industry in which participants are linked economically in unusual ways. Payment cards are useless to consumers unless merchants accept them, but merchants have no reason to accept cards unless consumers carry them and want to use them.” Consumers value widely accepted payment cards more, so issuers typically belong to large networks. But competition persists. The market sustains inter-network competition between networks owned by member banks, such as Visa and MasterCard, proprietary networks like Discover and American Express,and store-specific cards. What is more striking is the scope of intra-network competition. Visa and MasterCard, the two leading networks, are non-profit membership corporations with thousands of member firms. They provide infrastructure and a large network of users, and finance their services with membership fees. Despite strong network features, there is vigorous intra-network competition.

—Bryan Caplan and Edward P. Stringham, “Networks, Law, and the Paradox of Cooperation,” in Anarchy and the Law: The Political Economy of Choice, ed. Edward P. Stringham (New Brunswick, NJ: Transaction Publishers, 2007), 303-304.