Home » Glass Steagall: looking backwards, looking forwards

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Glass Steagall: looking backwards, looking forwards — 19 Comments

  1. I told you about the fool on the hill,
    I tell you man he living there still.
    Well here’s another place you can be,
    Listen to me.

    Fixing a hole in the ocean
    Trying to make a dove-tail joint-yeah
    Looking through a Glass-Steagall

  2. The only 5 bulge bracket investment banks that were not owned by commercial banks either failed, converted to commercial banks, or were forced into a shotgun marriage w/ a commercial bank.

  3. Glass-Steagall really had nothing to do with it and reinstating it would actually cause further harm to our banking system. The two real causes of the crisis were:

    1) The implicit backing of the Fed. Gov’t. and the Sub-prime mortgage enforcement issued by Fannie and Freddy which required banks to issue bad loans. Since they were implicitly guaranteed by the gov’t, all banks (commercial and investment) used them as investment vehicles, and the investment banks more so.

    2) The current bank insolvency crisis was more related to the easing of bank capital requirements in 2004 than to Glass-Stegall. By not requiring banks to maintain a certain amount of capital, it put them dangerously close to insolvency because of paper assets which have now turned out to be worthless.

    I don’t see how Glass-Steagall would have stopped the crisis, nor how reinstating it would do anything but further harm to our banking system.

  4. Sal,

    Would you be able to tell me more what this ‘rating’ system that pressured banks into giving more risky loans? I hear nothing about it from the mass media. I too wonder whether Glass-Steagall is the root cause of this mess.

  5. Neo,

    You wrote:

    “I have come to the conclusion that the problem is not too much or too little regulation per se, but regulation of the wrong type. . . .”

    I agree heartily, but let’s get even more basic than Glass-Steagall. There are two popular sore spots with the various crises of today: 1) too big to fail; and 2) outrageous executive compensation for leaders of failing companies.

    The first is controlled by enforcement of anti-trust legislation. When was the last time the govt brought anti-trust action? (Microsoft doesn’t count, because it was not about breaking up the company, but about the ubiquity of its internet explorer). One must go back to 1984 and the AT&T breakup to find anything meaningful. Keeping a business smaller allows for their failure to be absorbed by the economy (it also puts more people to work, because services are duplicated from company to company) and provides the consumer with more actual competitive choice thus encouraging a drive for quality.

    On the other hand executive compensation is controlled not by laws or presidential fiat limiting pay, but by demanding that boards of directors actually serve as the corporate overseers they were intended to be. The corporate world has become too inbred; one finds the same people siting of various boards, and many have social, political and business connections to one another. So if Neo is sitting on the board of “T, Inc.” and T is sitting on the board of “Neo, Inc.” is it any wonder that T and Neo can run unchecked as corporate executives?

    I am in the financial business, and I see time and time again that business and congress want to deal with treating the symptoms rather than the disease. Crises are not pleasant, but they are a normal and necessary part of the capitalist process; if prices didn’t go down and the weakest players weren’t eliminated, then prices would never go up and quality of products and services would suffer. I suspect that Detroit has realized this too late in the game.

  6. I have a problem with the term “regulate”. It is too innocuous a description of what Congress does. “Regulate” equals “man caused disaster” terminology for, just to pick one RANDOM example: Congress’ terrorism of the U.S. Auto Industry via CAFE standards. Holman Jenkins in 9/10/08 WSJ Online:

    Look at gallons consumed, miles driven, barrels imported or emissions emitted: CAFE has had no significant impact on energy consumption. Its sole practical effect has been to inflict on Detroit the need to produce, with high-cost U.S. labor, millions of small cars designed to lose money.

    CAFE has to be the most perverse exercise in product regulation in industrial history.
    […]
    Had CAFE not existed, there is no reason the Big Three today could not be competitive. As businesses do, they would have allocated capital to products capable of recovering their costs. Investments in fuel efficiency would still have taken place — to the extent consumers valued those investments. That is, if they were profitable.

    If Washington found this unsatisfactory, it could have done as the Europeans do and raised fuel taxes to coax the public to make different choices. Politically inexpedient? Well, yes, but that doesn’t mean CAFE is an effective substitute. It isn’t and never was.

    “When exposed to the piercing light of economic analysis, the alleged benefits of more stringent CAFE standards burn away,” Robert Crandall of the Brookings Institution wrote here last year. “Too bad these proposals will not be subjected to economic scrutiny before they become law.”
    […]
    Having squandered the domestic auto industry’s capital on millions and millions of cars that lost money, now Congress will squander the taxpayer’s capital.

    Thanks for your patience as I vented off topic.

  7. Sal: I think this crisis was multiply-determined. The two things you mentioned were certainly a big part of it, as I’ve written before in other posts.

    The point of this particular post is—just taking the single issue of Glass-Steagall—to show how difficult it is to determine how important a factor it was, and what to do about it now. Volcker certainly disagrees with you; he thinks it was a big factor. Personally, I feel I don’t have enough knowledge to come to a conclusion. But I wonder whether anyone does. And that’s a much bigger problem.

  8. Poor Santayana. Didn’t have a clue. Whether you remember the past or not, you will relive it, because some other SOB doesn’t.

  9. Well researched and reasoned, as usual, Neo. Of course now Obama has made a big move toward nationalizing an industry. What will he do next? Tell GM, Ford and Chrysler how many models of hybrids to produce and for what price? Are we talking Soviet style socialisim here?

  10. neo-neocon: I think you are correct in saying that this current mess has multiple causes – some more direct than others, but multiple nonetheless. Having practiced law in the area of securities for several years in the past, I am familiar with the need for, and importance of, both due diligence and disclosure in the process of assessing risk when making an investment decision. IMHO, one of the major causes of the financial disaster we are experiencing is that both sellers and buyers of securities consisting of bundles of mortgages began discounting “risk,” based upon an almost quasi-religious belief that housing prices would continue to go up forever and ever, much like the tulip speculators did once in Holland. Therefore, if a mortgage bundle contained a few “toxic” mortgages, the upward spiral in the value of the “non-toxic” mortgages in the bundle would minimize or completely eliminate the factor of “risk.” Then the housing bubble popped and “toxicity” overwhelmed the bundles. One of the original ideas behind Glass-Steagall was to minimize the “risk” to depositors in commercial banks by excluding such banks from the “risky” ventures for which investment banks, supposedly, were more prepared. Lesson? Investments carry risk, even if people choose to close their eyes and make themselves believe that they don’t, or, as the old adage says, “If it’s too good to be true (housing prices will ALWAYS keep going up) – it probably isn’t.

  11. Very good post, Neo.

    On the call in the comments for more anti-trust actions…I used to believe that (as many do) as well, and thought that anti-trust actions at the turn of the last century were critical.

    However, economic historians have pointed out a couple of things. When the anti-trust fervor was at its height back in the Teddy Roosevelt days, the price of goods from the “trusts” were going down, not up. To my knowledge, no one has ever been able to prove actual consumer damage from large companies, only theoretical damage. This isn’t as counter-intuitive as one might think…after all, if large companies are raising prices or keeping products off the shelves, then they create a competitive vacuum that gives other companies a level to get into their market. The only way for a big company to stay big is to keep consumers happy, and raising prices (in the medium to long-term) doesn’t do that.

    Second, large companies tend to self-destruct on their own. At one time it seemed critical to go after IBM…and they are still a huge company, but who would bother today?

    Microsoft was ruling the world, and they still play a critical part, but who cares about them in “trust” terms today? They are, in fact, too big to control the market. Their smaller more agile competitors are setting the agenda, the marketing, and the product mix, and Microsoft keeps trailing along, feebly trying to respond. When they do something overly controlling, they open an avenue for their competitors. When was the last time Microsoft was driving the agenda?

    However, there is one case where large companies pose a danger: When they are backed by government-imposed monopolies. Then they can indeed engage in all the things we’ve always worried about with trusts, because they don’t have the competition to worry about.

  12. I have heard the argument about the relative soundness of commercial banks versus investment banks, and as far as I can tell, it seems to be suported by the facts, so the Glass-Steagall argument loses much, if not all of it’s relevance.

    Let’s see, now just how can we improve risk management? Maybe by leaving the risk in place, instead of mitigating it with bailouts?

    Nah. Makes far too much sense.

    As far as I am concerned, for all the noise about financial crisis’, there have been far too few bankers and fund managers taking the fateful leap for me to believe it.

    Put the risk back in, and when the house of cards starts to topple, just let it.

    THEN you will see some real ‘risk management’.

  13. West: You are exactly right! All investments carry risk and the investor does all possible, or should do all possible, to manage the risk, e.g. a secured creditor wants the collateral to equal or exceed the debt secured thereby. But, sometimes, due to the ever present risk, investments fail. This is the way a market sorts itself out. Bailouts are meant to void the consequences of risk and, thus, prevent or forestall a market from sorting itself out and are merely a tactic of pouring money into a market mistake, much like shoveling dirt into an ever-deepening hole. Admit the loss and go on and let the free market work as it should and will.

  14. Thanks for the concurrance, Don.

    Just as an aside, I do not hold the banks alone culpable. I have personally heard many relatives, aquaintances, friends & friends of friends complaining about the beating they have taken in the market upheavals. I then politely ask them if they had any diversification – you know, some investments in muni’s, some in ‘stable’ commodities (gold, silver, etc), and then the rest in the higher risk/higher gain investments, and almost universally I get back a hangdog look & a grudging “No”.

    The entire culture has been besotted with the high gains available in the riskiest of investments, and everyone thinks that it is not their fault OR responsibility when one or more of these sectors take a hit. The irresponsibility has been a cultural pandemic, affecting everyone involved.

    There is really only one scapegoat here, and it has been essentially all of us collectively. And as I see it, we are going to collectively pay for it, too, even those of us who through circumstance or plan have not been directly involved.

    My personal feeling that the massive heaping of band-aids on an arterial wound is only going to make the eventual correction much worse when the piper comes to call.

  15. Everyone here is forgetting also that re-introducing Glass-Steagall would only make our remaining financial institutions even LESS competitive in relation to foreign competitors (often govt backed/subsidized) than prior to repeal of the act. If other nations no not format their financial institutions congruent with our own, re-instituting the act will not only be pointless, it will do great harm vis a vie our competitive edge with foreign financial institutions and see the only “industry” we have left–the financial one–move offshore.

  16. West, “relative soundness of commercial banks”? Not sure I agree with letting banks use things like goodwill, the present value of future tax write-offs and risky assets insured by AIG as safe capital. But lets not forget their influence on the rule book, either. Neo’s greatest omission, IMO, was the ~200mm spent by banks in lobbying the democrats to come out in number in support of the bill. Gramm, Leach, Bliley damaged transparency, moral hazard and gave us the consequences of a myopic incestuous focus on quarterly profit, but there are too many legacy political relationships for something so draconian as the seperation of investment and commercial banking to take place. The G20 are willing. Watch what the US does.

  17. I’m a laissez-faire capitalist and I think it is important to understand that we have had a “mixed economy” for about 100 years in this country (since the creation of the Federal Reserve and the Income Tax Amendment to the U.S. Constitution). Sure various presidents have moved from a relatively free system like Reagan to a more controlled system like Obama but they have really been very similar.

    So I admit that from by current viewpoint, our current economic situation should be blamed on our mixed system and having too much government interference in the economy. Blaming scapegoats like speculators, mortgage brokers, or Wall Street is easy.

    I recommend looking into the Austrian School critique of central banking for the real root cause of the financial crisis. They do a very commendable job. Murray Rothbard’s “America’s Great Depression” is very good.

    This is just my two cents.

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