Hobby Lobby and Politicized Banking
By: Brian Knight
Tags: Banking, Financial Services, Financial Regulation

I mentioned in an earlier blog post the concept of a “Coaseian bargain,” struck between government and industry, turning into a Faustian one. The example I used was banks seeking to withhold banking services to regulate and change the behavior of the putative bank customer. Banks provide essential services in the modern economy. In return, the public, as a matter of policy, has provided banks with a host of privileges, including barriers to entry, access to valuable services provided by the federal government, regulatory advantages over non-banks, and protection from failure. This centrality has been noticed by various constituencies who want to advance societal vision by curtailing access to certain legal products or services, thus leveraging the power of banks to promote the constituencies’ own goals. These groups — which include stakeholders such as bank customers as well as complete outsiders — have asked or pressured banks to use the banks’ power to play de facto regulator. As discussed in further detail in this article co-authored with Trace Mitchell, there are reasons why even those who are inclined to defer to lawful private choices should be skeptical of banks seeking to play this role. For example, the use by banks of their privileged position to play regulator by curtailing access to financial services runs contrary to the reasons those privileges were granted.

Which brings us to the Office of the Comptroller of the Currency’s (OCC) new proposed rule designed to promote fair access to financial services. The rule was put forward in response to a rise of politicized banking, in which banks refused to do business with certain industries in an effort to either drive those industries out of business or force them to change their legal practices to conform with the preferences of the bank or whomever the bank wants to please. It is this use of the banks as a tool of de facto regulation that is different from a bank declining to provide services to a potential customer for traditional financial reasons like risk or profitability. It is even different from a hypothetical in which a bank’s leadership has a conscientious objection and simply does not want to be involved in a particular activity, without trying to impede the activity from happening otherwise. The banks’ use of their privileged positions to coerce policy outcomes is also, the problem that may justify regulation to prevent it from happening.

The rule would prohibit banks from preemptively denying services to entire legitimate industries, provided the banks provide similar services to others. It adopts a posture more consistent with antitrust principles, and would be applied only to large banks that have sufficient market power to impact price and availability of banking services. It also imposes certain prescriptive requirements, such as requiring banks covered by the rule to establish “quantitative, impartial risk-based standards” and only deny service if a prospective customer fails to meet them, rather than just prohibiting banks from using certain criteria when deciding whether to provide services.

The rule is controversial, to put it mildly. One recent critique was written by John Berlau, of the Competitive Enterprise Institute, in National Review where he argues that the rule fails to respect the right of banks (or the people therein) to freedom of association or conscience and that the rule will backfire on conservatives.

I am sympathetic to these concerns, but I think this argument somewhat misses the mark. For one thing, there are significant and material differences between the circumstances in Hobby Lobby and much of what is going on with banks. Second, while I admire Mr. Berlau’s optimism regarding the alternatives to and costs of regulation, I’m not certain I share it. Appreciating those distinctions is important to assessing whether regulatory intervention may be appropriate.

(As a threshold matter, I would like to make clear I am not arguing the merits of the proposed rule. Rather I am talking about the underlying issue of banks trying to use their privileged position as a way to force change on the lawful actions of bank customers and the propriety of intervention.)

What Hobby Lobby did, and didn’t, do

Mr. Berlau cites to Justice Samuel Alito’s majority opinion in the Hobby Lobby case for the proposition “a corporation is simply a form of organization used by human beings to achieve desired ends.” As the opinion held, people do not leave their rights, including freedom of association, at the door when they form a corporation. To Mr. Berlau, there is a distressing parallel between the government forcing Hobby Lobby to offer contraceptives that violated the company owners’ religious beliefs and making banks extend services to a firm they disagree with. While superficially appealing, there are some important and nuanced differences between what happened in Hobby Lobby and the problem the OCC is trying to address.

First, we should acknowledge the limits to the Hobby Lobby decision. The Supreme Court didn’t say that freedom of conscience was unlimited in Hobby Lobby. Rather, it looked at a specific statute, the Religious Freedom Restoration Act (RFRA), to see if the Department of Health and Human Services (HHS) had met its burden of showing that there was a compelling government interest with no less burdensome method of achieving it. The court found that HHS did not meet this burden. The Court reached this decision in no small part because the HHS had established an alternative means for employees of religious non-profits to access contraception, on the same terms as employees of other firms, but without the non-profit paying for it. The Court noted that that program could simply be extended to for-profit firms, allowing employees to access contraception (the alleged compelling government interest) without the religious for-profit firms having to pay for something they objected to.

The Court also took pains to discuss the legal and practical limitations of the decision. Yes, the logic applies to public firms as well, but as the Court points out, figuring out just whose conscience needs to be protected in a public firm is challenging and may make it difficult for a public firm to make such a claim. Yes, Hobby Lobby can’t be made to pay for contraception, especially because there was a ready-made alternative that served the “compelling government interest” just as well. But this doesn’t mean a firm could invoke religious conscience for any act; a sufficiently compelling reason with no better means of achieving it could still justify burdening a company’s conscience.

When we compare the circumstances of Hobby Lobby to what is going on with banking there are several important differences. The first is the intent of the firms that motivates their actions or refusal to act.

Conscience vs Control

The firms in Hobby Lobby did not want to be forced to offer coverage for certain contraceptives because they felt those contraceptives violated the religious beliefs of the firms’ owners. The firms’ refusal was not to prevent their employees from getting access. The firms did not object to their employees getting the coverage in some other manner, but their religious convictions did not allow them to pay for it. Likewise, the firms didn’t seek to avoid paying for contraception to drive the companies making contraception out of business or change the ability of people to obtain those drugs. There is no evidence of any motivation by the firms, or some other party with influence over the firms, to use a refusal to pay for contraception in their employee health plans as a vehicle to impose their views or change the overall availability of contraception. Rather, they just didn’t want to be forced to pay for something they objected to on religious grounds.

Contrast this to recent activity by banks and various constituencies who seek to influence them. Not only have the decisions not generally been cast as a true matter of conscience, but from firearms to climate to private prisons the decision to refuse or condition access to financial services is framed, either by the banks themselves or the constituencies pushing the banks, as an effort to impose change on others, including calls for industry coordination to increase the effectiveness of such actions. Frequently banks aren’t simply refusing to engage with a customer while being otherwise indifferent as to whether the customer can accomplish his or her goal. Rather the banks, and the constituencies that have influence over them, want access to the financial system to be a source of leverage against firms and industries they object to. It isn’t just (or at all) about conscience; it is about using finance as a tool of control when people can’t get what they want through the political system, or as one politician put it when talking about using banks as a source of leverage to force change: “There’s more than one way to skin a cat, and not everything has to be done through legislation explicitly[.]”

The difference in intent is relevant. While it is possible that a bank could make a legitimate claim under Hobby Lobby based on a conscientious objection, it seems a stretch to extend such a claim from protecting one’s own beliefs to attempting to impose one’s beliefs on others, or even, potentially, to protecting one’s beliefs at a significant cost to others.

Benefits and Statutory Intent

Another important difference between banks and the firms in the Hobby Lobby case is the legal and policy framework they operate in. Hobby Lobby was decided on statutory, not constitutional, grounds. By passing RFRA, Congress established a policy that placed the obligation on the government to avoid burdening private religious values unless absolutely necessary. Congress could have exempted the Affordable Care Act from RFRA, but chose not to. As such, the Court finding that Hobby Lobby and other firms did not need to pay for certain contraception, provided their employees still got access on functionally identical terms, was a vindication of Congress’ intent.

The present situation with banks is materially different. Banks are unique in the amount of government support and protection they enjoy. As described more fully here, these supports can include barriers to entry through discretionary chartering and granting of deposit insurance, regulatory advantages over non-bank competitors, preferential access to government provided services such as the Federal Reserve’s payments system, direct financial support to prevent firm failure, and sometimes pure bailouts. In addition, these supports can result in banks being able to raise funds more cheaply than they would be able to otherwise.

These benefits are important to the analysis. Banks enjoy the benefits they do because they are viewed as essential to an effective economy and the government support is supposed to help them provide services more effectively and safely than were it not available. Public policy has made banks central to financial intermediation. This may reflect a “Coaseian bargain” where a specific industry gets special support in exchange for providing essential services, in this case financial intermediation.

We can debate whether this “bargain” is a good idea or not, but it exists. While these benefits are justified to the American people as benefitting them, whether by facilitating economic transactions or preventing harm from bank failures, a side effect is that banks have power and importance, and, in the case of some banks, a continued existence, that they may not have in a more free and open market. If banks then refuse to do what they were granted unique power to do with in order to de facto control others by limiting their choices this denies the American people the benefit of their bargain and goes from Coaseian to Faustian.

To be clear, I’m not arguing that the instant the government provides a business with access to anything the business should lose all control or discretion. This “quid pro quo” theory of regulation, where the government gets to leverage the provision of any benefit, even something as minimal as building and maintaining roads, as a justification to demand an unrelated “favor” from the business should be rejected.

However, what we are talking about here is making certain that an extensive set of privileges and benefits are being used for the purpose for which they were granted, and that they are not abused. There are government-granted privileges that are unique to banks (and that are unlike roads, which are made for everyone to use), which were granted for specific purposes. When banks try to leverage their privileged position to play regulator they frustrate and distort those purposes. This isn’t a case of trying to bootstrap public utility status because someone used a road. This is ensuring that the overarching justification for a pronounced departure from traditional markets isn’t turned on its head.

Mr. Berlau is absolutely right that the best option to address this problem would be to make banking more of a free market, but we need to recognize that politically that is unlikely to happen anytime soon, if at all. We are likely stuck with the present system for a while, and if we can’t change the entire system we need to ensure the system we have isn’t abused.

It is possible there are alternatives to government regulation to combat this abuse, and Mr. Berlau mentions one, but I’m unfortunately skeptical as to its efficacy. Mr. Berlau argues that conservatives could form their own shareholder pressure groups to form a counterweight to “woke capitalism.” However, we should acknowledge that the reality of equity ownership in the US presents a significant headwind. The majority of equity shares are held by institutional investors (pension funds, insurance companies, etc.) and three asset managers (BlackRock, State Street, and Vanguard) are the largest individual investor in almost all S&P 500 firms. Yes, individuals are the beneficial owners of the underlying shares, but they don’t vote those shares, the institutional investors and asset managers do. If those institutions trend progressive, or simply don’t care, it will be hard for individual shareholders to have much impact.

Further, I wonder if we wouldn’t be better served as a society if we had less politicization of financial services (including for conservative purposes), not more. Our banking system is a weird beast, and not particularly well suited to deciding what people should and should not be allowed to do. To the extent banks try to play regulator, and we then prop up banks, we risk forcing taxpayers of whatever political persuasion to “feed the hand that bites them.” It may be that we would all be better off if we de-militarized banking and kept the social questions to the political and regulatory environment with its procedural safeguards, and (if we must), other commercial areas which lack the barriers to entry and government support found in banking.

Finally, the article expresses concern that any regulatory effort to prevent banks from trying to play regulator may be turned around against conservatives. While I understand this concern I don’t think the only thing standing between us and the weaponization of financial services and financial service regulation by progressives is a refusal to intervene when banks seek to play regulator. Progressive philosophy simply tends to be fairly accepting of government utilizing regulation to impose positive (in the sense of affirmative) obligations on private actors to further “positive” (in the sense of desirable) ends. This isn’t something that is taboo for progressives. They will do it anyway, and they do not need conservatives or libertarians to participate to validate the approach

Now, I will agree to the extent that what is done may matter. A rule or law that imposes an affirmative duty to serve could undercut resistance to the “banks as public utility” argument, though it would presumably also create further distance from the “banks as chokepoint” argument because a defining characteristic of public utilities is a general duty to serve all. However, a rule or law that maintains bank discretion but restricts the discretion to prevent misuse, more akin to what we see in anti-discrimination law, seems less prone to abuse. To be clear, I don’t think this will ultimately make the difference. If there is a winning progressive coalition you will see progressive regulation, but at the margin the method may matter.

Of course, there are arguments against any regulatory intervention at all and it is possible that any cure would be worse than the disease. We are firmly in “no solutions, only trade-offs” territory due to an unfortunate situation where political and regulatory decisions made over the course of centuries are compounding increased political polarization. It is possible that the OCC is making a mistake, but banks are not like Hobby Lobby. Banks are intertwined with government privilege and power, and some are attempting to use that to exert broader control. We should recognize this reality.