As the economic recovery continues to sputter, there’s no end in sight for the blame game over the crisis and how it all began. In the latest controversy over what happened and how to fix it, law makers are contemplating resurrecting Depression-era legislation to make sure the housing bubble burst of 2008 never happens again.
Menage a Too-Big-Too-Fail. From right to left: Former Texas Senator Phil Gramm, Clinton Treasury Secretary Robert Rubin, and ex-Citigroup CEO Sandy Weill — the men who brought about the end of Glass-Steagall. Photo courtesy of Colonel Flick.
For those of you who cannot – or better yet, do not – watch HBO’s The Newsroom, The Banking Act of 1933 (better known in political circles as “Glass-Steagall” after the legislation’s authors) separated the activities of commercial banks and investment banks. Following the infamous “Black Tuesday” crash of 1929, Senator Carter Glass and Congressman Henry Steagall sought to end the conflicts of interest that occurred when commercial banks were able to underwrite stocks and bonds. In short, they sought to create a banking system where Mom and Pop could get a loan for their shoe store that would be safe even if the financial sector, as Olivia Munn’s character on The Newsroom so delicately put it in a recent episode, “burned to the ground.”
In the 1960s, regulators had begun to loosen the leash, allowing commercial banks to engage in a wider array of securities activities in increasingly forgiving interpretations of the law. Thirty years later, during the Clinton administration, Federal Reserve Chairman Alan Greenspan allowed for securities underwriting to constitute up to 25 percent of the business a commercial bank could conduct, rendering any prior separation of investment and commercial banking basically ineffectual — with rare exception.
Riding the momentum of economic growth and underhanded deregulation, Travelers Insurance CEO, Sandy Weill, and Citicorp head, John Reed, sought to merge their companies in 1998. Their only obstacle was that their proposed merger was exactly what Glass-Steagall was designed to prevent.
Facing unrelenting lobbying efforts from Weill and Citicorp as well as pressure from a conservative Congress to deregulate, President Clinton declared Glass-Steagall “no longer relevant.” In late 1999, he signed into law the Gramm-Leach-Billey Act (or GLBA), allowing investment and commercial banks to share the same bed all they wanted.
Creative Glass-Steagall protester. Photo courtesy of Francesco Fiondella.
Fast forward 13 years, a couple of recessions, two wars, two bubbles, two bursts, the end of Lehman Brothers, a few government bailouts, and two Citigroup CEOs later – lawmakers and financial experts, including Sandy Weil himself, are singing quite a different tune in regards to the relevancy of Glass-Steagall.
“What we should probably do is go and split up investment banking from banking, have banks be deposit takers, have banks make commercial loans and real estate loans, have banks do something that’s not going to risk the taxpayer dollars, that’s not too big to fail,” Weill told CNBC’s Squawk Box in late July. His words sent ripples through the financial and political communities, jettisoning a new debate over Glass-Steagall into the foray.
The question now becomes: Does the repeal of Glass-Steagall bear any blame for our current economic strife? As with so much in American politics, the answer depends on whom you ask. There are compelling arguments on both sides, with conventional wisdom siding in favor of Sandy Weill. On the surface, after all, the math is pretty simple – if part of the problem is that banks are too big to fail, what harm could be done by any effort to break up the banks? Other wolf-criers like Tom Heonig, head of the Federal Insurance Deposit Corporation (a federal entity created by Glass-Steagall), say the only way to prevent another financial crisis is to separate commercial and investment banking once and for all.
However, many reputable political commentators — even those who think too-big-to-fail banks are a bad thing — counter that the devil is in the details, and considering the complexity of the financial transactions involved that lead to the 2008 crisis, there are many. As Washington Post columnist Steven Pearlstein noted in an op-ed, the banks at the heart of the crisis — Merrill Lynch, Bear Stearns, and Lehman Brothers — were all pure investment banks. Thus, reinstating Glass-Steagall wouldn’t fix the problem.
“The same goes for Goldman Sachs, another favorite villain of the left,” Pearlstein continued. “The infamous AIG? An insurance firm. New Century Financial? A real estate investment trust. No Glass-Steagall there.”
Others like The American Bankers Association argue that without the repeal of Glass-Steagall, the financial sector would have sustained further damage in 2008, as they did in January 2010 report:
“[Repealing Glass-Steagall] also played an important role in enabling an orderly resolution of troubled investment banks by allowing their assets and liabilities to be absorbed into a bank holding company with its full complement of regulation, strong capital requirements, and on-site examination. Without GLBA these Wall Street firms would have faced limited options and several would have failed – which would have destroyed what little confidence remained in the midst of the global financial crisis.”
So what do our elected leaders think? The official position of the Obama Administration (via Treasury Secretary Tim Geithner) is to let the latest financial reforms in the form of the Dodd-Frank Act work their magic before trying to make any more big fixes. Though, where a purist’s interpretation of a reinstated Glass-Steagall would call for a schism in a deeply consolidated banking system, Dodd-Frank goes a bit farther — asking that banks justify their size with the necessary capital to save themselves should things go awry.
Citibank. Photo courtesy of Kiwanja.
On the other side of the isle, bankers are having reservations about the newly minted Republican vice presidential candidate and conservative firebrand, Wisconsin Representative Paul Ryan. Back in May, Ryan told constituents that he opposes Dodd-Frank yet supports a provision inside it (known as a Volcker Rule) that allows the CFTC to regulate banks along the lines of Glass-Steagall with not much more authority than the Fed used in the ’90s to de-fang the law.
“If you’re a bank and you want to operate like some nonbank entity like a hedge fund, then don’t be a bank,” said Ryan. “Don’t let banks use their customers’ money to do anything other than traditional banking.”
Will the Volcker rule inside Dodd-Frank be enough? Like so many of the provisions of the reform bill, only time will tell.