In 1999, President Bill Clinton signed the Gramm-Leach-Bliley Act, effectively repealing some of the strongest protections against financial meltdown our legislature had ever created.
The 1933 Glass-Steagall Act was a response to the stock market crash of 1929 and the ensuing Great Depression, and it accomplished two very important things. The first was the establishment of the Federal Deposit Insurance Corporation (FDIC), protecting bank deposits up to a certain limit in order to prevent bank runs and maintain a modicum of consumer confidence in their banks. The other important piece, the part that is germane to this discussion, was the prohibition against bank holding companies owning other financial companies like securities and insurance firms.
Glass-Steagall was the bane of the banking industry for decades. As far as they were concerned, these were outdated and unnecessary regulations which prevented them from making the kind of gangster-money that was their birthright. Since the early 1980’s, the financial sector had been lobbying to remove these restrictions.
From the 1987 Congressional Research Service report on preserving Glass-Steagall:
The argument for preserving Glass-Steagall:
1. Conflicts of interest characterize the granting of credit – lending – and the use of credit – investing – by the same entity, which led to abuses that originally produced the Act.
2. Depository institutions possess enormous financial power, by virtue of their control of other people’s money; its extent must be limited to ensure soundness and competition in the market for funds, whether loans or investments.
3. Securities activities can be risky, leading to enormous losses. Such losses could threaten the integrity of deposits. In turn, the Government insures deposits and could be required to pay large sums if depository institutions were to collapse as the result of securities losses.
4. Depository institutions are supposed to be managed to limit risk. Their managers thus may not be conditioned to operate prudently in more speculative securities businesses. An example is the crash of real estate investment trusts sponsored by bank holding companies (in the 1970s and 1980s).
The argument against preserving the Act:
1. Depository institutions will now operate in “deregulated” financial markets in which distinctions between loans, securities, and deposits are not well drawn. They are losing market shares to securities firms that are not so strictly regulated, and to foreign financial institutions operating without much restriction from the Act.
2. Conflicts of interest can be prevented by enforcing legislation against them, and by separating the lending and credit functions through forming distinctly separate subsidiaries of financial firms.
3. The securities activities that depository institutions are seeking are both low-risk by their very nature, and would reduce the total risk of organizations offering them – by diversification.
4. In much of the rest of the world, depository institutions operate simultaneously and successfully in both banking and securities markets. Lessons learned from their experience can be applied to our national financial structure and regulation.
So essentially the arguments for preserving the Act were “we’ve been down this road before, we know where it goes, and that’s why this law exists.”
As for the arguments against; number 1 seems a stronger argument for increased regulation of securities firms and foreign institutions operating within the U.S. rather than an argument for further deregulating consumer banks. Numbers 2 and 3 just seem naive, but perhaps only because hindsight is 20/20. Number 4 is only partially true; most notably China maintains a wall between commercial and investment banking, and intends to continue to do so in the wake of the current crisis.
G7 member nations have not historically done so, but the legal and regulatory frameworks in these countries for financial firms are different than ours, by virtue of the fact that they have not had such a separation. This goes back to argument number 2; repealing Glass-Steagall would be fine, as long as strong regulation was in place to prevent conflicts of interest and firms becoming “too big to fail.”
Never underestimate the venality of politicians. In 1998, regulators allowed Citicorp to acquire Traveler’s Group, a move that was technically still illegal under Glass-Steagall. So the obvious solution was to simply undo the law. In 1999, the banking industry got its way with Gramm-Leach-Bliley.
In fairness, while the bill derives its common name from 3 Republican congressman who sponsored it, it was signed by a Democratic president and received bipartisan support in the House. Doing favors for campaign contributors is a bipartisan issue.
The apologists for GLB point out, rightly, that it was not responsible for the mortgage crisis. But let’s not conflate the sub-prime crisis with the current economic problems we’re facing. Reading the proponents (even FactCheck.org’s refutation of claims that GLB is responsible for our current economic woes) is oddly quaint at this point in the game. In the early fall of last year, the statement that “Bank of America, Citigroup, Wells Fargo and J.P. Morgan Chase have weathered the financial crisis in reasonably good shape” seemed sound when the Dow was still above 10,000 – now they are patently absurd.
The meme that says that Fannie and Freddie were the problem, that subprime mortgage holders are at fault, is the classic “blame the victim” routine. Risky mortgages are only a problem when they’re over-leveraged – when debt is treated as if it were wealth.
The problem is really quite simple. What the repealing of Glass-Steagall has ultimately done is allow the financial sector to balloon to a ridiculous size, with derivatives now accounting for $1.114 quadrillion (that’s $1,114,000,000,000!) – 22 times the GDP of the entire world. Too much of our economy is based on people pushing around numbers on paper, and it’s being concentrated in fewer and fewer hands.
Given the fact that banking and investment firms have been allowed to merge into behemoths like AIG and CitiGroup, we can be held hostage by a small handful of “too big to fail” firms – “bail us out with no strings attached, or the economy will crash.”
Too big to fail means too big to exist. Otherwise, we set the stage for forced corporate welfare – we socialize the losses, and privatize the profits. If we don’t break these companies up and restore a financial sector that can absorb individual firms going under, we will be bailing them out for decades to come.
1 Response
Nice writing. You are on my RSS reader now so I can read more from you down the road.
Allen Taylor
Posted on March 25th, 2009 at 12:15 am
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