Economics, Financial Services, Pethokoukis

Do we need a 21st-century version of Glass-Steagall? A few thoughts

From Reuters:

A small bipartisan group of senators on Thursday introduced legislation that would break up Wall Street’s megabanks by separating traditional banking activity from riskier financial services. The bill, called the 21st Century Glass-Steagall Act, has an uncertain future, but it shows some lawmakers’ frustration that banks have only continued to grow since the 2007-2009 financial crisis. “The four biggest banks are now 30 percent larger than they were just five years ago, and they have continued to engage in dangerous, high-risk practices that could once again put our economy at risk,” said Democratic Senator Elizabeth Warren from Massachusetts, one of the sponsors of the bill.

The other sponsors are Republican Senator John McCain from Arizona, Democratic Senator Maria Cantwell from Washington, and Senator Angus King, an independent from Maine who caucuses with the Senate’s Democrats.

The legislation would bring back elements of the 1933 Glass-Steagall Act, which divided commercial and investment banking, and was repealed in 1999. The legislation introduced on Thursday would separate the operations of traditional banks with accounts backed by the Federal Deposit Insurance Corp from riskier activities such as investment banking, insurance, swaps and hedge funds.

1. Consider: it is hard to find a direct causal relationship between the repeal of Glass-Steagall restrictions and the Financial Crisis. Both Bear Stearns and Lehman were investment banks, while JPMorgan, which combined investment and commercial banking, is still around. And as NYU economist Larry White, among others, has pointed out, “if Glass-Steagall had been on the books in 2007- 08, the big commercial banks could not have absorbed Bear Stearns and Merrill Lynch. By the same token, Goldman Sachs and Morgan Stanley could not have found shelter from the storm by converting themselves to bank holding companies.”

2. Luigi Zingales concedes the above points, but make this case for the old rules:

Glass-Steagall helped restrain the political power of banks. Under the old regime, commercial banks, investment banks and insurance companies had different agendas, so their lobbying efforts tended to offset one another. But after the restrictions ended, the interests of all the major players were aligned. This gave the industry disproportionate power in shaping the political agenda. This excessive power has damaged not only the economy but the financial sector itself. One way to combat this excessive power, if only partially, is to bring Glass-Steagall back.

3. Thomas Hoenig’s bank restructuring plan is similar to the Warren-McCain plan but would allow “underwriting securities (stocks and bonds) and advisory services,” in recognition, I believe, of the realities of the Financial Crisis (such as White mentions) as well as the competitive pressure that drove the Glass Stegall repeal.

First thoughts, more to come …

3 thoughts on “Do we need a 21st-century version of Glass-Steagall? A few thoughts

  1. If we had sound money, lack of Glass-Steagal would not matter. I much prefer putting a stake in the heart of the Federal Reserve, whose fiat currency is responsible for EVERY boom and bust cycle. But sans the latter, perhaps a well crafted G-S act is better than nothing. Analyze well before anything is passed, as I have very little faith in the sponsors.

  2. The more that you replace markets with rules, mandates, restrictions, and regulatory judgment (requiring regulatory exemptions) the more you make government rather than customers the arbiters of who wins and loses in business. Before Glass-Steagall, the financial people stayed in New York and Chicago and the other financial centers. After Glass-Steagall, and the increasing load of regulation since then, the number of financial industry advocates in Washington has been steadily increasing. Trade associations used to be headquartered where the business took place. Today it is malpractice not to have your headquarters in the capital. A neo-Glass-Steagall, and the mountain of new government rules, would just compound the problem.

  3. No.

    We didn’t need the 20th century version of Glass Steagall, either.

    G-S had absolutely nothing to do with the financial meltdown, and as we are seeing with Dodd-Frank, regulation designed to prevent loss can actually result in perpetuation and expansion of too big to fail.

    Insulating intermediaries from loss creates adverse consequences, and the fundamental problem during the meltdown: moral hazard.

    Another try at a G-S-like regulatory framework would do nothing to prevent future problems, and may actually cause them.

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