An Autopsy of the Glass-Steagall Act

If the repeal of the Glass-Steagall Act of 1934 is the reason that we got into this financial mess, then the path to destruction began long before the intermingling of banks, brokerages, and insurances companies with the passage of the Gramm-Leach-Bliley Act of 1999. Republicans have justifiably accused the Democrats of the fall of the financial systems by allowing Democrat supported regulators to not do their respective jobs of regulating. Not to be outdone, the Democrats have accused the Republicans for the demise of the banking system through the effort to de-regulate. And in fact, this charge by the Democrats is also true. Acting in a bipartisan manner, the Democrats and Republicans have unanimously undermined the very system that they earlier created.

Now that we’re clear as to who is responsible for our current malaise, let’s look at the other parties that are vital to the repeal of the Glass-Steagall Act. First and foremost is the Federal Reserve. Once the politicians set the ball in motion the Fed picked it up and started running. The Fed’s stance on the matter was, “if anyone is gonna change things it might as well be in our favor.” To preempt any discussion of the matter, the Federal Reserve drew up its own vision of the way things should be. But there were those who didn’t quit agree with this vision.

Along comes the FDIC with an alternate view of the way things should work. The FDIC says, “Why should the Fed write the rules but we have to insure the failures without any input?” This eventually turned into a turf war between regulatory agencies. The question wasn’t about the sensibility of repealing the Glass-Steagall Act, instead the debate was about who was going to get the biggest piece of the regulatory pie.

Recognizing that the only debate regarding repealing Glass-Steagall was who gets the most regulatory power, the insurance, brokerage and banking industries decided to take action. Nothing puts the nail in the coffin more than ignoring the current law in anticipation of the expected change. The string of mergers that followed the Swiss Bank and Dillon, Read and Co. partnership in May of 1997 ensured that Glass-Steagall was effectively repealed.

Finally, the last participant in this process was the American public. The public lacked the understanding, or concern, that the repeal of such a law was holding back the flood that would eventually push our economy to the brink. Advocacy groups who routinely rail against the banks and the Federal Reserve had lost, in the eyes of the public, the credibility necessary to demonstrate why this time, as opposed to all the other times, things were different and we as the public needed to debate the issue of the repeal of Glass-Steagall Act.

Glass-Steagall is officially a relic of a bygone era. It seems that our politicians, both Democrat and Republican, will now have to create a new regulatory framework that will ensure their own viability as a going concern. All that is left is the turf war over who gets the 1% majority to run Congress and the White House. To bad the duopoly in government has a death grip on any and all competing ideas.

Timeline/Sources:

• July 1983, Treasury Secretary presents to the President the proposed bank industry deregulation that includes “both bank and thrift holding companies to engage in a wide range of securities, insurance, and other financial activities.” Rosenstein, Jay. "Reagan hears Treasury's dereg plan; growing opposition causes delay action." American Banker (July 8, 1983)

• July 11, 1983, President sends to Congress the Financial Institutions Deregulation Act. “Deregulation bill is sent to Congress: proposal would expand bank, thrift activities." American Banker (July 11, 1983)

• January 17, 1984, Treasury Secretary feels that competitors to the banking industry are "…chipping away at [the system]. If that continues and banks aren't given the identical opportunities to other financial services companies, the banking system's base will simply erode and could collapse.” Ringer, Richard. "Regan says Bush panel to finish report this week. (Donald T. Regan; George Bush)." American Banker (Jan 17, 1984)

• In February 1985, acting general counsel Margery Waxman “recommends that Treasury Secretary James Baker add provisions empowering banks to underwrite mutual funds, and to allow bank holding companies to own securities brokerage houses, items missing from last year's [1984] Senate bill.” Naylor, Bartlett. "Will Baker, former bank attorney, fight hard for new banking laws?." American Banker (June 3, 1985)

• November 5, 1985, “George Gould, nominated to be Treasury undersecretary for domestic finance, seeks additional powers for banks to underwrite commercial paper and mutual funds.” Naylor, Bartlett. "Treasury to limit new bank powers quest, nominee says." American Banker (Nov 8, 1985)

• “Banking lawyer Peter Wallison, former general counsel at the Treasury Dept, is promoting the same ideas for bank reform he touted in the early days of the Reagan administration. Wallison believes that restrictions on capital should be relaxed and banks allowed to diversify into markets more lucrative than loans. He says Congress is too focused on capital and has weakened good deregulation legislation promoted by the Bush Administration.”Cummins, Claudia. "Former Reagan official still fighting for banks." American Banker (August 14, 1992)

• “Federal Reserve Board Chairman Alan Greenspan testified recently in favor of repealing the provisions of the Glass-Steagall Act that prohibit affiliations between investment banking firms and member banks.” Isaac, William M. "Fed plan for securities powers isn't prudence but turf war. " American Banker. (March 9, 1995)

• The proposal to repeal the Glass-Steagall Act was submitted to the Federal Deposit Insurance Corporation. The FDIC said that it was in favor of repealing the provision that prohibited banks from affiliating with investment banks. Isaac, William M. "Fed plan for securities powers isn't prudence but turf war. " American Banker. (March 9, 1995)

• May 15, 1997, Swiss Bank Corp. announces that it will buy investment bank Dillon, Read and Co. Ring, Niamh. "Swiss bank to acquire Dillon Read; fate of municipal division is unclear." The Bond Buyer (May 16, 1997)

• June 9, 1997, BankAmerica acquires investment bank Robertson Stephens. Treaster, Joseph B. "BankAmerica to Buy Robertson, Stephens Investment Company." The New York Times (June 9, 1997)

• July 7, 1997, NationsBank acquired investment bank Montgomery Securities. Haber, Carol. "Montgomery goes to NationsBank in rich and risky deal, some say." Electronic News (1991) 43.n2175 (July 7, 1997)

• November 15, 1999, President repeals Glass-Steagall Act by signing the Gramm-Leach-Bliley Act of 1999. Iowa Republican Jim Leach “hailed the successful bipartisan effort after decades of failure.” Anason, Dean. "Clinton Enacts Glass-Steagall Repeal." American Banker 164.219 (Nov 15, 1999)

Comments

[Hitz:]

I agree that commercial banking and investment banking should be differentiated as one IB puts on risk the money of depositholders wherein the profit on the risk is passed on to shareholders while in case of losses, the depositholders suffer. The differentiation will not create "too big to fail" institutions.

Mar 31 06:11 AM

[Carousel:]

Eh, here's the cookbook:

Step one: Force banks to underwrite mortgages to unqualified buyers (including illegal immigrants) through threats of legal action and restrictions on M&A. "It's for the children!" Culprits: HUD Secretary Andrew Cuomo and AG Janet Reno.

Step two: Provide a government-backed buyer for mortgages that would "jet issue" mortgages with minimal documentation. Culprits: Fannie Mae executives Franklin Raines, Jamie Gorelick, Jim Johnson, et. al.

Step three: Allow the GSEs to securitize the debt for resale with the implicit guarantee of the US government standing behind the instruments. Culprits: see #2.

Step four: Allow the GSEs to "invest" millions in Congress to prevent any scrutiny of executive pay-packages, capital-to-asset ratios, hedging strategies and risk management... even in the midst of multi-billion dollar accounting scandals. Culprits: Barney Frank, Maxine Waters, Congressional Black Caucus, Chris Dodd, etc.

Step five: when the GSE equity prices melt down because of poor management and accounting, devastating the capital-to-asset ratios of AIG and other financial institutions that held billions in GSE instruments, blame the entire debacle on Bush.

Mar 31 08:25 AM

[jamesa40:]

Can you please explain how the aversion of repeal of Glass-Stegall would have caused Fannie/Freddie to not have imploded or how the rules to banks to lend to subprime clients would have been any different? Whether or not Glass-Stegall would have been repealed, the advancement of the markets would have still lead to much of the mess we have today. Sure, brokerages, insurance companies and banks wouldn't have been one in the same, but their collapse may have been even more spectacular without access to the combined entities capital base.

Mar 31 08:34 AM

[pacman1947:]

What a fascinating historical piece, blaming all politicians for the debacle, in both parties. This is a centrist view. I guess the real question is why do we want to keep the current system in place if it doesn't work? The old system worked and kept the markets from becoming engulfed in worthless paper. Glass-Steagall is the old, Gramm-Leach-Bliley is the new, and the new created loopholes of a multi-trillion dollar nature.

I'm a conservative. I like old stuff that works vs. new stuff that doesn't. Let's bring back Glass-Steagall and repeal Gramm-Leach-Bliley, OK?

Mar 31 09:01 AM

[russ:]

Re: Carousel; "Force banks to underwrite mortgages to unquailifed buyers (including illegal immagrants)." That is baloney and a myth of the right wing nuts. There are laws and rules to prevent the well documneted prejudice against some groups and areas of town when income and property facts were the same. No one forced banks or mortgage brokers to offer no equity or 110% value loans, nor were they forced to steer borrowers into high risk variable rate loans. Also, I particularly like the way you slipped in a little racist dig, that was real class.

Mar 31 09:15 AM

[Carousel:]

Russ, I am the descendant of legal immigrants. This is not racism. It's the law. If you promote breaking certain laws, which ones are acceptable to break?

As for the facts. Perhaps you could explain the million-plus web pages -- from the mainstream media -- that describe the ability of illegal aliens to secure home mortgages. It is a well-known fact among every mortgage broker in California that millions of the bad loans were given to illegals.

Here's the San Francisco Chronicle in 2006, for example... not exactly a right-wing newsletter:

www.sfgate.com/cgi-bin... ("Selling illegal immigrants the American dream")

How many articles like this should I find before you admit you were wrong and apologize?

Mar 31 09:21 AM

[canonicalman:]

Why not simply reinstate Glass-Steagall? Wouldn't that be the sensible thing to do?

Mar 31 09:35 AM

[Allan Frain:]

To regulate or not. To insure or not. With deregulation and insurance (read bailouts) we have assembled the worst possible scenario. Unless, of course, you are a banker. The bankers get both freedom and security, which is being paid for from the freedoms and securities of society as a whole.

Mar 31 10:16 AM

[wg:]

carousel is quite correct. None of this would have happened--NONE Of IT--if banks had not be A. Permitted, B. Encouraged, and C. Ordered, to abandon sound lending practices. There would have been NO toxic derivatives, because the mortgages would have been sound in the first place.

Mar 31 11:14 AM

[Gregman2:]

Excellent piece. The Federal Trade Commission also allowed so much consolidation of these mega banks, with thought given to traditional reserve requirements. Securitization (as a means of fractional reserve money creation) was a huge experiment initially.

Mar 31 11:49 AM

[kdo:]

Glass Steagal is a straw man. I'd love to hear an explanation why the European banking system has never ever had such a regulation enforcing the separation of IBs and banks and does not have a history plagued by crisis.

The reality is that the problem is one of the "shadow" banking system or "bank like entities". Glass Steagal did not have anything to do with the fact that IBs could directly securitize mortgages from mortgage brokers and sell them to institutions, hedge funds and money market funds, effectively completely bypassing the banking system. How come there is no screaming about how we needed to regulate money market funds more closely as a bank like entity, or highly leveraged institutions like GE finance? Glass Steagal did not allow GE finance to happen. Most of the bank like entities or shadow banks existed because they morphed from investment vehicles towards using short term paper to leverage returns. The world changed faster than the regulatory framework and the regulatory framework must catch up. That is not the fault of Glass-Steagal.

Mar 31 03:41 PM

[PainfullyAware:]

Great Work on summarizing the demise of Glass-Steagall.

Those that believe that Dems and Repubs are different pay no attention to action or event. They are one - The Money Party or The Corruption Club. There is very little representation in DC anymore; K-Street has more influence than any state in the union.

Do not use yourself as the mean - you will always be disappointed.

To Assume Benevolence Is Foolish.

The Complexity Of Corruption IS Vast.

Mar 31 03:46 PM

[Carousel:]

Mark Levin's new book _Liberty & Tryanny_ has a great description of this whole meltdown. It's a must.read

Mar 31 04:42 PM

[conceptwizard:]

I wish I had a dime for everytime President Cllinton spouts off about the current economic dilemma and what he would do if he was in the white house. He has received no heat or taken no responsibility whatsoever for the current mess. Clinton is the ultimate enabler with a stroke of his mighty pen he discarded the only thing keeping the greed in check by repealing Glass-Steagall . That was the single most important hurdle to be knocked over by the Financial Warlords. This effectively gave the Warlords the keys to the gates. Greenspan came clean and admitted he made a mistake when he recommened Clinton sign it, Clinton should own up and take it on the chin as well. Obama has surrounded himself by Clinton officials. We should expect NO CHANGE at all and EVEN BIGGER GOVERNMENT! I believe this is already more than evident. Tyler Durdins Seeking Alpha's atricle (a must read) yesterday on AIG and the memo sent to him from one of their traders should eliviate any doubters on the legitimacy of the Governments commitment to the taxpayers. They knowlimgly let taxpayer money flow through AIG which produced the biggest writedown in its history to fill the pockets of the Financial Warlords.

Mar 31 07:15 PM

[Sannity:]

It would be nice if people would read to learn rather than to find justification for their particular point of view; this article is an attempt at analysis rather than justification or blame. Too much time in front of FOX appears to have corrupted the capacity for reasoning. (Summary: lots of people screwed up; those who ignore history are doomed to repeat it.)

Nov 01 11:32 AM