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Reflections on Glass-Steagall and Maniacal Deregulation
Today marks the 10-year anniversary of the passage of the repeal of the 1933 Glass-Steagall Act and related legislation. It is an anniversary worth noting for what it teaches us about forestalling financial crises, the consequences of maniacal deregulation, and the out-of-control political power of the megafinancial institutions.
The repeal of Glass-Steagall removed the legal prohibition on combinations between commercial banks on the one hand, and investment banks and other financial services companies on the other. Glass-Steagall's strict rules originated in the U.S. government's response to the Depression and reflected the learned experience of the severe dangers to consumers and the overall financial system of permitting giant financial institutions to combine commercial banking with other financial operations.
Glass-Steagall protected depositors and prevented the banking system from taking on too much risk by defining industry structure: Commercial banks could not maintain investment banking or insurance affiliates (nor affiliates in non-financial commercial activity).
As banks eyed the higher profits in higher risk activity, however, they began in the 1970s to breach the regulatory walls between commercial banking and other financial services. Starting in the 1980s, responding to a steady drumbeat of requests, regulators began to weaken the strict prohibition on cross-ownership.
Despite herculean efforts by Wall Street throughout the 1990s, Glass-Steagall remained law because of intra-industry and intra-regulatory agency disagreements.
Then, in 1998, in an act of corporate civil disobedience, Citicorp and Travelers Group announced they were merging. Such a combination of banking and insurance companies was illegal under the Bank Holding Company Act, but was excused due to a loophole that provided a two-year review period of proposed mergers. The merger was premised on the expectation that Glass-Steagall would be repealed. Citigroup's co-chairs Sandy Weill and John Reed led a swarm of industry executives and lobbyists who trammeled the halls of Congress to make sure a deal was cut. But as the deal-making on the bill moved into its final phase in Fall 1999, fears ran high that the entire exercise would collapse. (Reed now says repeal of Glass-Steagall was a mistake.)
Robert Rubin stepped into the breach. Having recently stepped aside as Treasury Secretary, Rubin was at the time negotiating the terms of his next job as an executive without portfolio at Citigroup. But this was not public knowledge at the time. Deploying the credibility built up as part of what the media had labeled "The Committee to Save the World" (Rubin, Fed Chair Alan Greenspan and then-Deputy Treasury Secretary Lawrence Summers, so named for their interventions in addressing the Asian financial crisis in 1997), Rubin helped broker the final deal.
The Financial Services Modernization Act, also known as the Gramm-Leach-Bliley Act of 1999, formally repealed Glass-Steagall. Among a long list of deregulatory moves large and small over the last two decades, Gramm-Leach-Bliley was the signal piece of financial deregulation.
Repeal of Glass-Steagall had many important direct effects but the most important was to change the culture of commercial banking to emulate Wall Street's high-risk speculative betting approach.
"Commercial banks are not supposed to be high-risk ventures; they are supposed to manage other people's money very conservatively," writes Nobel Prize-winning economist Joseph Stiglitz. "It is with this understanding that the government agrees to pick up the tab should they fail. Investment banks, on the other hand, have traditionally managed rich people's money -- people who can take bigger risks in order to get bigger returns. When repeal of Glass-Steagall brought investment and commercial banks together, the investment-bank culture came out on top. There was a demand for the kind of high returns that could be obtained only through high leverage and big risk-taking."
This is a very important part of the story of what created the financial crisis.
What lessons should be learned from the 10-year debacle?
First, Glass-Steagall's key insight was in the need to treat regulation from an industry structure point of view. Glass-Steagall's authors did not set out to establish a regulatory system to oversee companies that combined commercial banking and investment banking. They simply banned the combination of these enterprises. Cleaning up the current mess, we need strategies that focus on industry structure -- meaning, especially, that we must break up the big banks -- as well as more traditional regulation.
Second, we need to return to Glass-Steagall's more particular understanding: depository institutions backed by federal insurance protection cannot be involved in the risky, speculative betting of the investment banking world. (Notably, the Glass-Steagall problem is now worse than it was before the financial crisis, following JP Morgan's acquisition of Bear Stearns, and Bank of America's takeover of Merrill Lynch.) Moreover, we need not just to reinstate Glass-Steagall, but infuse its underlying principles throughout the financial regulatory scheme. Commercial banks should not be in the business of speculation. They have a job to do in providing credit to the real economy. They should do that. Their job is not to engage in betting on derivatives and other exotic financial instruments.
Third, giant financial institutions exercise too much political power, and for that reason alone must be broken up.
Fourth, we need broad reform in the area of money and politics. We need public financing of Congressional regulations, even stronger lobbyist reforms, and tight restrictions to close the revolving door through which individuals spin as they travel between positions in government and industry.
A year ago, as the financial crisis was unfolding, it seemed very plausible that these reforms would be seriously debated in Congress. Three months ago, it appeared that Wall Street had successfully maneuvered to keep them off the table. But in Congress a recognition is now settling in that regulatory reforms on the table are failing to deal with the problems of size and industry structure -- and that there may be a severe political price to be paid for such failure. Suddenly, it seems that common sense may again be politically viable.
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30 Comments so far
Show AllThe financial industry and its amply rewarded allies in congress don't want to be regulated. Billions were made in the reckless investment boom. The voting public has limited choice. We need public financing of elections and REAL democratic decision making.
Based on Obama Inc.'s performance during the past year (starting with his zealous support of an unconditional trillion dollar TARP bailout in Sept. 2008) Obama will veto any attempt Congress makes to revive Glass-Stegall.
Are you insane? First off, congress ain't making any attempt to revive Glass-Stegall. And second, even if they did, it would have to be a VERY strong push from every facet on the left (it would take 60 Senate votes), so there is NO CHANCE Obama would veto it.
But again, that bill has zero chance of reaching Obama's desk in the 111th.
"lobbyists who trammeled the halls of Congress…"
Did they use rope or fishing nets?
It was 'Slick Willy' Bill Clinton, at the behest of now Treasury Secretary Tim Giethner among others, who overturned Glass-Steagal.
So the foundations of today's present economic collapse can be laid squarely at the feet of the Democratic Party. That the Republicans and Bushco benefitted mightily is just a coincidence.
Right? *wink*
Slick Willy may have signed the bill, but it was voted on strictly party lines in the Senate with almost every Democrat voting against it. The House was a little more evenly split... but make no mistake, this was a Republican bill, and passed late on the eve of Thanksgiving weekend.
But yes, Clinton absolutely should have vetoed this turd sandwich. One of his many mistakes.
Mistake? It was the plan. Robert Rubin was Clinton's guy all the way. Clinton also refused to back up Arthur Levitt when he wanted to put the brakes on accounting scams '97-'98 and Congress threatened to cut his budget.
Are you sure about the vote? The Commodities Futures Trading Act of 1999 which banned the regulation of derivatives was voted in with 90 or 99 Senators on board. Can't imagine the repeal of Glass Steagall would have been so different.
Wow. I had to go back and research because that's how I remembered it,... but you're right. Here's what happened:
Phil Gramm (Republican from Texas) introduced the bill in the Senate, and Jim Leach (Iowa Republican) in the House. Almost no Democratic Senator voted for the passage of the Senate bill, but it passed 54-44. Then after the 2 bills were merged in the Conference committee, the Senate passed the final bill 90-8.
Nice catch. Thanks.
Not only that but also when Bill Clinton was cornered in a progressive forum on his NAFTA signing, he lied and said they would have passed it over his veto. He was FOR NAFTA from day one. To say he wanted to veto it but couldn't was typical Clinton two step.
By the way, notice that Hillary is worth about 20 million (not counting real estate). Neither of the Clintons were multimillionares before they got to the white house. They, like Bush and Obama, are justs cogs in the empire machine.
Isn't that the new way? Gives them another opportunity to confuse us by voting against it before they vote for it.
Weissman sez: "We need ... to close the revolving door through which individuals spin as they travel between positions in government and industry."
***
That 'revolving door' has been removed already. The oligarchs found the experience too dizzying, so they replaced the door with high-speed conveyor belts.
Goebbels,
it's even worse than that. Alexander Cockburn of Counterpunch just reported that the new "regulatory" reforms have a devious but significant loophole using lawyer language to continue the credit default swap racket while telling us they are regulating it. These sneaky Wall Street lawyers think they are so clever.
Wall Street is the enemy of the USA, period. And naturally, their goon, Geithner, doesn't "favor" a Tobin tax. Of course. The Kosher Nostra cannot stand traceable financial transactions (that could lead to accountability and we certainly can't have that...).
Remember, accountability is for the middle class and poor. This is the USA.
Aye, AGG -
I was going for the cheap chuckle earlier, but in truth there is no need for a revolving door because there are no longer any walls between K Street and the 'elected' branches of government. THAT particular 'merger and acquisition' continues to be the most under-reported story in the U.S.
Well said. And it wasn't a hostile takeover. They had so many moles inside the government that they were welcomed with open arms.
To deregulate is to eliminate control and its core definition does not specify from whom. Look it up in the dictionary (http://dictionary.reference.com/browse/deregulate). The word deregulation is effect a misnomer. This was really shifting regulations in favor of the corporate elites against the working class. The regulations against the working class have been tightened while the CEOs have been given lax regulations. I think a better term for this is "shifting regulations" instead of deregulation.
Well, this leaves out a lot of factors that led to the current crisis. It is widely theorized that the original legislation was pointless and unnecessary, that the investment services of the banks had little to do with the Great Depression. Similarly, there are so many other factors that contributed to our current situation, some of which was too much legislation.
This crisis is a real estate crisis and credit crisis. The government practically controls this market entirely in the US with so much legislation and subsidies and agencies since WW2. How is more government involvement in a market they micromanage excessively already going to create any better results?
As the author points out while contradicting his whole theory at the same time, the banks were essentially doing everything they did recently for decades. The Gramm bill was just a token gesture at the time it was passed. And again as the author points out the only significant use it has been since then is to help with the bailouts. The things that did change were the easy money policy of the Fed after the dotcom bust and regulation to encourage subprime lending in the nineties. Also many other factors as well but Glass-Steagall has nothing to do with it. The US is the only country that has this kind of regulation, so you would think we would be doing the best based on the nonsense in this article but we are not.
What we need is degovernmentalization. Let's not forget the greatest government power for controlling and managing the economy is the Fed. Anyone who cares about peace should look into why federal banks were established throughout history. It is to fund war. Without them, the governments cannot afford war. Without them, we would not have had WW1, WW2, the Holocaust, the Vietnam War. We would not be bombing children on the other side of the planet right now.
Giving the government such financial power is the same thing as being pro-war. Someone might hate bankers and think they are sleazy but to hire the government as your henchman to get revenge is the same thing as taking money out of your pocket and sending it Washington with a note saying "Please use my money to drop bombs on the poor and children, thank you, sincerely, gullible citizen. PS. I hate bankers, don't you?" Look at the whole picture before swallowing the rubbish in this article and wake up.
ATLAW - I've never seen a post on CD that spewed so much garbage as yours.
"It is widely theorized that the original legislation was pointless and unnecessary, that the investment services of the banks had little to do with the Great Depression."
"Widely theorized" by whom? Right-wing greed merchants, who hate regulation but who never turned down a gov't bailout they didn't deserve? Real "free-marketeers", they.
"This crisis is a real estate crisis and credit crisis."
Which was brought on by bogus derivatives and Credit Default Swaps, with little actual enforcement of existing regulations by the SEC, FDIC and other regulatory bodies; and now those same banks, who were given trillions are sitting on that money and not loaning it out, or are using it for yet more asset/equities and commodities trading and stock market speculating to enrich themselves. All at the expense of the taxpayers and the greater economy. And, they still have toxic balance sheets that have yet to be cleaned up.
"Also many other factors as well but Glass-Steagall has nothing to do with it. The US is the only country that has this kind of regulation, so you would think we would be doing the best based on the nonsense in this article but we are not. "
Unless you're living in Mr. Peabody's Wayback Machine, Glass-Steagall is now gone. Has been for 10 years, remember?
"What we need is degovernmentalization. Let's not forget the greatest government power for controlling and managing the economy is the Fed."
Yet another load of hogwash, since the Federal Reserve Banks are not "federal" at all. They're private institutions, which loan money to the US federal gov't at interest.
Nice try, but no cigar.
Seditious:
Excellent points.
The proof of all the malfeasance is in the files at WTC7.
"As the author points out while contradicting his whole theory at the same time, the banks were essentially doing everything they did recently for decades."
Nope. The author points out no such thing. As usual, right wing "libertarian" distortion. This is what the author said
"As banks eyed the higher profits in higher risk activity, however, they began in the 1970s to breach the regulatory walls between commercial banking and other financial services. Starting in the 1980s, responding to a steady drumbeat of requests, regulators began to weaken the strict prohibition on cross-ownership."
Regulations being weakened, is NOT doing everything they did recently for decades.
"This crisis is a real estate crisis and credit crisis. The government practically controls this market entirely in the US with so much legislation and subsidies and agencies since WW2. How is more government involvement in a market they micromanage excessively already going to create any better results?"
No it isn't. No matter how much you right wing "libertarians" want to pretend, no matter how much you right wing "libertarians" want to gloss over that, the total value of all the bad mortgages is a tiny fraction of the bad debt that the banks accrued on their gambling on credit default swaps.
"Also many other factors as well but Glass-Steagall has nothing to do with it. The US is the only country that has this kind of regulation, so you would think we would be doing the best based on the nonsense in this article but we are not."
Again. Right wing "libertarian" distortion and outright lies. Pretty much every major economy in the world had similar regulations on their banks. In response to the repeal of Glass-Steagall, and the Free Market Uber Alles propaganda spread by "libertarians" like you, many of the laws were either outright repealed, or loosened. And not surprisingly, it is those countries that copied the US the most, such as the UK, that have ended up in an equally big hole.
ATLAW: Michael Rozeff, retired finance professor and libertarian has supported Glass-Steagall as the only way to go as long as we have FDIC, SEC, etc. And I don't see those going any time soon.
It defies logic to think you can combine high risk investment banking with low risk banking. They are two different animals and could metaphorically represent the idiotic genetic engineering schemes and scams that big banks fund. Of course, they should have been allowed to fail but they weren't. That is the reality that doesn't seem to change. Separating the two banking functions is not the greatest evil on earth, it just keeps institutions in human scale.
Our Constitution was designed to limit concentration of power. We can argue its' effectiveness there but concentrations of economic power are just as dangerous to liberty as political power. And yes, I think all institutions should be shrunk down to size, from corporate entities to gov't. Even mega-churches creep me out, altho I do not want to legislate about it.
Have you read Small Is Beautiful by EF Schumacher?
Also, I believe the real estate crisis/credit crisis are symptoms. The real problem is a debt crisis--gov't debt, corporate debt, personal debt. We've been riding a pumped up, debt driven economy and it's time for a very painful correction.
Time to make public the Clinton Circus that destroyed the
Glass Steagle act and gave us Nafta that outsourced our industrial base to China and Mexico. Not happy with that destruction, Hillary was outsourcing other industries to India.
Why are so many people protecting the Clinton Deal?
The Financial Services Modernization Act sure did not waste any time
transfering nearly all of America's wealth to the top 0.1%
atime
« It’s About the Death of Small Business
The 10-Year Yield is the Giveaway
November 11th, 2009
By David Goldman
We have had the longest winning streak on the S&P in three years, and gold hits new records every day — and the 10-year yield has fallen in the course of the week. That’s not a dog that didn’t bark, but a dog that did an Elvis impression. The simple explanation is: dollar devaluation. All US assets are cheapening to foreign investors, including Treasury securities. With unemployment at umptysteenth percent (17.5% of the workforce by the comprehensive measure) American prices simply won’t move at the rate at which the dollar is devalued. Labor will remain cheap. That’s why Treasury securities look cheap to foreigners. The Fed has effectively placed a giant wealth tax on America by devaluating the dollar.
All that has happened is that dollar devaluation has revalued the price of international tradeables — gold commodities, Intel, luxury condos in Manhattan — while the grass roots of the US economy continue to dry up. The stock market looks bubbly. How long will the bubble last? As one of my mentors in the business, Credit Suisse chief US economist Neal Soss, like to put it: Bubbles last until they feel like fundamentals.
This entry was posted on Wednesday, November 11th, 2009 at 9:13 pm
Inner Workings Copyright 2008-2009 Asia Times Online (Holdings), Ltd.
Visit Asia Times Online by clicking here.
atime
« Link to my interview last night on Kudlow and Co.
The 10-Year Yield is the Giveaway »
It’s About the Death of Small Business
November 6th, 2009
By David Goldman
As I said on Larry Kudlow’s CNBC show Wednesday night (see link in previous post), the big issue in the US economy is the massacre of small business. That’s why the household survey shows that 558,000 Americans “became unemployed” during October, while the establishment survey of payrolls shows a decline of only 190,000 jobs. The establishment data, which are collected from larger businesses, are more reliable; the household survey is based on telephone interviews with randomly-selected households. But the numbers are so large as to make clear that small businesses are shutting down.
With commercial and industrial lending by American banks down 13% since September 2008, and most banks continuing to “tighten lending standards” in the Fed’s official poll, this is not surprising. Wal-Mart will make it through a recession; not the tea-cozy shop down the mall corridor, much less the real-estate agency in the half-abandoned exurb. The global speculative grade default rate, as Moody’s reported this week, has risen to a post-Great Depression high of 12%. Credit lines for small businesses (including home equity, credit cards, and all the other devices entrepreneurs use to fund themselves) will continue to shrink.
Numerous analysts have made the point that in all previous post-war recoveries, it was small business that led job creation. During the 1980s and 1990s large businesses lost employment and small businesses grew. The fact that job losses at small business are evidently far higher than those at large businesses does not make this look like any recovery at all.
This entry was posted on Friday, November 6th, 2009 at 8:58 am and is filed under General.
Inner Workings Copyright 2008-2009 Asia Times Online (Holdings), Ltd.
Visit Asia Times Online by clicking here.
The recommendations are what should be done and the sooner the better. However, there is one problem: The banks are recovering because of their investment arms not their banking arms. As long as the market keeps going up the investments the banks are making will make them very profitable. We will know when the banks again act like banks when they begin to make loans and provide credit. If we can force them to do that by taking away their investment arms, then our economy will begin to grow for real.
"(Reed now says repeal of Glass-Steagall was a mistake.)"
Freedom means a lot of things to a lot of people. But some meanings of freedom are far more destructive than others. The finance elites' meaning of freedom is the ability to ignore past mistakes, and repeat them over and over, creating severe economic instabilities that disrupt lives. The people are much more adversely affected than the elites, naturally. But USans will continue to defend such freedoms, as long as they are somewhat cushioned from the fallout by the petro-opiates.
So we can see that this supply-side manipulation of demand in the energy/materials markets, calculated strategy of mass addiction, has created this fallout of mass paralysis while the elites play smash-up derby against societies and ecosystems.
When the petro-opiates run out, or much preferably when USans decide to take proactive responsibility, they will no longer tolerate the elites' "ooops, sorry, heh heh we wuz wrong again". One strategy to help usher sanity back in would be to support policies that destabilize the flow of the petro-opiates. Another is to promote alternative energy sources to get people off the addictions that paralyze them in the political arena.
Just what if an idea came along that could manage to "get people off the addictions that paralyze them in the political arena" ???? Just what if someone should come up with an alternative energy source so abundant that it would be "too cheap to meter" What if such an invention could be manufactured in virtually every community in the country, or for that matter, the world???? and what if rather than patenting and exclusivity, it were placed by it's inventor in the Public Domain ?????
Any Thoughts????
Bring Glass Steagall back, and nationalize the banks to save the country and others as well.
Let the people run the institutions which have and have had so much negative impact on their lives and lets have economic democracy.
AD
Gee how about another preview?
Bring Glass Steagall back, and nationalize the banks to save the country and others as well.
Let the people run the institutions which have and have had so much negative impact on their lives and lets have economic democracy.
AD