I have long felt that the repeal of Glass-Steagall, and the near collapse of the financial system 8 years later, were an interesting correlate, and while I have not sat down and studied the content of G-S and compared it to the collapse, others have. Those who think there’s causation include James Rickards at US News & World Report:
The oldest propaganda technique is to repeat a lie emphatically and often until it is taken for the truth. Something like this is going on now with regard to banks and the financial crisis. The big bank boosters and analysts who should know better are repeating the falsehood that repeal of Glass-Steagall had nothing to do with the Panic of 2008.
In fact, the financial crisis might not have happened at all but for the 1999 repeal of the Glass-Steagall law that separated commercial and investment banking for seven decades. If there is any hope of avoiding another meltdown, it’s critical to understand why Glass-Steagall repeal helped to cause the crisis. Without a return to something like Glass-Steagall, another greater catastrophe is just a matter of time.
In 1929, the music stopped, the stock market crashed and the Great Depression began. It took eight years from the start of the boom to the bust. Subsequent investigations revealed the extent of the fraud that preceded the crash. In 1933, Congress passed Glass-Steagall in response to the abuses. Banks would be allowed to take deposits and make loans. Brokers would be allowed to underwrite and sell securities. But no firm could do both due to conflicts of interest and risks to insured deposits. From 1933 to 1999, there were very few large bank failures and no financial panics comparable to the Panic of 2008. The law worked exactly as intended.
In 1999, Democrats led by President Bill Clinton and Republicans led by Sen. Phil Gramm joined forces to repeal Glass-Steagall at the behest of the big banks. What happened over the next eight years was an almost exact replay of the Roaring Twenties. Once again, banks originated fraudulent loans and once again they sold them to their customers in the form of securities. The bubble peaked in 2007 and collapsed in 2008. The hard-earned knowledge of 1933 had been lost in the arrogance of 1999.
Cyrus Sanati at the New York Times reports on the same theme:
But 10 years later, the end of Glass-Steagall has been blamed by some for many of the problems that led to last fall’s financial crisis. While the majority of problems that occurred centered mostly on the pure-play investment banks like Lehman Brothers, the huge banks born out of the revocation of Glass-Steagall, especially Citigroup, and the insurance companies that were allowed to deal in securities, like the American International Group, would not have run into trouble had the law still been in place.
“Commercial banks played a crucial role as buyers and sellers of mortgage-backed securities, credit-default swaps and other explosive financial derivatives,” Demos, a nonpartisan public policy and research organization, wrote in a report discussing the problems it said were caused by the repeal of Glass-Steagall.
“Without the watering down and ultimate repeal of Glass-Steagall, the banks would have been barred from most of these activities,” Demos said. “The market and appetite for derivatives would then have been far smaller, and Washington might not have felt a need to rescue the institutional victims.”
Yaron Brook and Don Watkins at Forbes disagrees:
By far, the single most cited example of this financial “deregulation” is the Gramm-Leach-Bliley Act (GLB), which partially repealed the Glass-Steagall Act thirteen years ago today. Regulatory evangelists including Nobel Prize economist Joseph Stiglitz and recent senatorial candidate Elizabeth Warren, not to mention the Occupy Wall Street protesters, have named the overthrow of Glass-Steagall as public enemy number one.
Stiglitz, for instance, in a lengthy piece for Vanity Fair, could only muster two examples of the deregulation he thinks bears primary responsibility for the crisis: the repeal of Glass-Steagall and theSEC’s 2004 decision to raise banks’ debt-to-capital ratio from 12:1 to 30:1. The latter, of course was not deregulation, but re-regulation. For the regulatory evangelists, the repeal of Glass-Steagall is all they’ve got—and what they’ve got ain’t much.
Glass-Steagall was enacted in 1933 to create a firewall between commercial and investment banks: commercial banks could not underwrite or deal in securities, and investment banks could not accept deposits. The Act also restricted commercial banks from being affiliated with any company that underwrote or dealt in securities.
But by the 1990s, the affiliation provision was widely viewed as unnecessary and even harmful to financial institutions. In 1999, President Clinton signed GLB into law. Although it left the bulk of Glass-Steagall in place, it ended the affiliation restrictions, freeing up holding companies to own both commercial and investment banks.
…
GLB [the act repealing Glass-Steagall] didn’t cause the financial crisis—and, when push comes to shove, the regulatory evangelists must admit as much. Stiglitz, in the same Vanity Fair article, concedes that Glass-Steagall did nothing to “directly” cause the crisis. Warren, meanwhile, confessed to New York Times reporter Andrew Ross Sorkin that Glass-Steagall would probably not have stopped the financial crisis, but that she was pushing to reinstate it because, in Sorkin’s words, “it is an easy issue for the public to understand and ‘you can build public attention behind.’”
Meanwhile, Senator Byron Dorgan (D – ND) tries on the hat of Delphi (from the NYT article):
One of the leading voices of dissent was Senator Byron L. Dorgan, Democrat of North Dakota. He warned that reversing Glass-Steagall and implementing the Republican-backed Gramm-Leach-Bliley Act was a mistake whose repercussions would be felt in the future.
“I think we will look back in 10 years’ time and say we should not have done this, but we did because we forgot the lessons of the past, and that that which is true in the 1930s is true in 2010,” Mr. Dorgan said 10 years ago. “We have now decided in the name of modernization to forget the lessons of the past, of safety and of soundness.”
Mr. Dorgan still feels the same way. “I thought reversing Glass-Steagall would set us up for dramatic failure and that is exactly what has happened,” the senator told DealBook on Thursday. “To fuse together the investment banking function with the F.D.I.C. banking function has proven to be a profound mistake.”
Senator Richard Shelby from the other side of the aisle also voted against repeal and so gets a feather in his cap as well.
