Glass-Steagall

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What is Glass-Steagall?

Glass-Steagall was the 1930's new deal regulation that said Commercial and Investment had to be separated. There would be no universal banks.

  • The theory was that consumers were easily confused by the differences and so didn't understand the risks they were taking, and this would prevent banks from deceiving the public -- since they'd know the difference between walking into one kind of bank or the other.
  • There's an added layer of abstraction where by requiring Commercial Banks to transact with Investment banks to do certain things, there was more transparency (governments could audit those two companies transaction).
  • Because of those transactions (between the two types of banks), there's more waste (two companies get a piece of the transaction instead of one in universal banks), but there’s theoretically less conflict of interest (investment is looking out for equity, and commercial is looking out for cashflow, and somehow this helps consumers). So in their theory, there's less returns (more waste), and thus less risks. In truth, there’s just more inefficiency and the same risk.

Why add/remove Glass-Steagall?

The New Deal was about increasing waste/bureaucracy and employing more people. Their Keynesian economic theory (long disproven) was that by making things less efficient (requiring more people to do the same job, and injecting bureaucracy), that you employed more people, gave them more money, so more people were better off. This is called the broken-window fallacy in economics (seen benefits matter, hidden costs do not); it is wrong and rebuked in economic circles, but it plays well in the political and media spheres. We also know Glass-Steagall didn’t do anything valuable (which was why it was removed bipartisan support).

How do we know?

  • Transparency inside banks hasn’t been a problem, so inter-bank transfers didn’t help (there wasn’t a problem here).
  • Adding or removing a step, didn’t alter what happens. One way bank (a) talked to bank (b) to do your trades — the other way bank has dept. (a) talk to dept. (b) and does the trades. But nothing changed except overhead.
  • There’s no difference in leverage (either by them or you). They had the same incentives either way, as did you. There’s no advantage to the customer for having an adversarial relationship between banker and securities broker.
  • Europe and Asia had never had Glass-Steagall! That's why it was removed. American banks were having to compete with European and Asian banks on an uneven field; they had Unified banks and we didn’t. We had an extra layer, and less services and lower returns than if they had tighter coupling). And none of those banks had a problem in the 66 years between G-S and American repeal of it. If it was protecting us, why hadn't they had problems?
  • Most banks didn’t unify (most stayed separate), and if G-S was the problem, then during the collapse it would have been the unified banks that had the biggest problems (over-leveraged/under-capitalized). It wasn’t. The Unified banks outperformed the Commercial banks (Countrywide) and the Investment Banks went out of business (Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers, Bear Stearns). The Unified banks that never had problems; JP Morgan Chase (Unified) bailed out Bear Stearns (Investment), while B of A (Unified) helped by taking over Merrill Lynch (Investment) and Countrtywide (Commercial). This is backwards from what GST says should have happened!
  • This has been widely researched, after a few bad books and articles promoting this G-S theory. Bill Clinton, the CBO, the SEC, and dozens of other economists all concluded the same thing: Glass-Steagall had nothing to do with the crisis, or the credit freeze
  • Not only that, studies concluded GS had done nothing to help in the Depression, and research into the debates from the era demonstrate it was passed based on complete bullshit, even for the time. It wasn’t economics but flim-flam. It was always a confidence scam to dupe the public into thinking the politicians had done something to make banking safer. But even back then, the people at the time knew, passing it was bullshit. There’s just some that bought into the lie so hard that they refuse to learn this to this day.

No one has ever adequately explained how removing GS could cause a bubble or the credit markets to freeze, or how GS could have stopped the bubble, let alone why investment or commercial bankers would knowingly shoot themselves in the foot, why politicians would let them get away with it (if crimes were committing, prosecuting them would get them fame/votes), and so on.

They usually stop at step 1 — which is that leverage helped inflate the bubble and that eventually popped. OK. But Universal banks weren’t the problem, and how did the credit crunch happen? How did loaning them money fix it? And so on — they want to stop here, because everything else proves that their theory is more political than historical.

Film Flam

There are a few books that preyed on the desire for it to be the fault of Capitalism/Greed/Deregulation by Wall St., and then uses technical mumbo-jumbo, to sounds credible. But they are flim-flam. Like these:

The whole theory is that GS, "prevented the banks from using insured depositories to underwrite private securities and dump them on their own customers. This ability along with financing provided to all the other players was what kept the bubble-machine going for so long". Or so he claims.

But again:

  • If Unified Banks could over-leverage themselves and sell bad instruments to their customers, which will go bad, and cause a credit crunch (in their own company), then why didn't this happen to any of the Unified banks?
  • We know that this didn’t happen in 2008, it was the Investment banks (not Unified banks) that had the problems.
  • More than that, the bubble was inflated in Real Estate Sector (Commercial bank territory), not in Unified or Investment bank areas. So the theory is disproven by reality.

"The GAO confirmed that leverage at the CSE Holding Companies had been higher at the end of 1998 than at the end of 2006 just before the financial crisis began.”

~ (GOA) Government Accountability Office

http://www.gao.gov/new.items/d09739.pdf

If the problem was over-leverage, we should have had the Financial crisis in 1998, not in 2007

Deregulation

Not only that, In 1997, there were 23,422 restrictions on the industry (banking/finance), a level that increased to 26,235 (up 17%) by 2008. So there was no deregulation, only increases in regulation.

On top of that, the pure number of regulations doesn’t fully quantify how much larger and more complex regulation has gotten over time. Dodd-Frank for example is 22,000 page alone.

Those claiming deregulation are ignorant about history and congress (which is continuously writing new laws, and very rarely repealing old bad ones).

There might have been mistargeted regulation (meaning a failure of regulation), but there was no deregulation that allowed this to happen.

If you have any better explanations that you’ve read, let me know and I’ll look into them and debunk them as appropriate. But all of them have been variants of that hole-riddled self-contradictory theme.

References


Financial crisis of 2007-2008 : CRA, Fannie/Freddie TheoryBig Fraud TheoryGlass-SteagallFinancial Terms