This debate over Glass-Steagall needs to die already.
You’re forgiven if you have no idea what I’m talking about. Few Americans have reason to know or care a lot about the Glass-Steagall Act, an arcane, Depression-era law that restricted the kinds of activities banks could engage in.
The law was partly repealed in 1999, but for some reason the Democratic presidential candidates have become obsessed with it — and, specifically, with bringing it back.
They’ve brought it up at every debate and expounded on it on the trail. It’s become the left’s litmus test for whether a politician is “tough” on Wall Street. Sen. Bernie Sanders (I-Vt.) and Martin O’Malley advocate reviving Glass-Steagall, ergo they’re populist heroes; Hillary Clinton does not, ergo she’s in the pocket of Big Banks.
But Glass-Steagall had nothing to do with the 2008 financial crisis. It’s a distraction from the reforms we still need to prevent the next one.
So what is this blasted law exactly?
Glass-Steagall was intended to separate commercial banks (which take deposits and make loans) from investment banks (which underwrite and deal in securities, such as stocks and bonds). After the Depression, the securities business was considered too risky for federally insured commercial banks to engage in, or even be “affiliated” with (meaning, have the same ownership). As a result, the law said these two kinds of banks couldn’t be owned by the same holding company.
Over subsequent decades, however, markets blurred the lines between these activities; businesses began to raise funding by issuing securities through investment banks rather than by taking loans from commercial banks. As a result, the Federal Reserve gradually loosened the provision barring holding companies from owning both commercial and investment banks, and Congress formally repealed it. A commercial bank with federally insured deposits still can’t engage in the securities business, but it can refer clients to an affiliate that offers such services.
What does all this have to do with the financial crisis?
Pretty much nothing.
If the repealed provisions of Glass-Steagall had still been on the books, almost none of the institutions at the epicenter of the crisis would have been covered by it.
Bear Stearns, Lehman Brothers, Merrill Lynch, Goldman Sachs and Morgan Stanley were basically stand-alone investment banks. AIG was an insurance company. Fannie Mae and Freddie Mac were government-sponsored entities that bought and securitized mortgages. Washington Mutual was a traditional savings-and-loan. And so on.
Glass-Steagall, or the lack thereof, is a red herring.
Given this, it’s not clear why Glass-Steagall enjoys such pride of place in Democratic discourse.
Maybe Bill Clinton’s signature on the repeal allows for murky insinuations that the Clintons were complicit in the financial crisis. Or maybe the Democratic presidential underdogs think name-dropping an 80-year-old banking law makes them sound like they kinda sorta know something about financial regulation.
Instead, they just reveal the depths of their ignorance.
Worse, their oversimplified calls to “bring back Glass-Steagall” have diverted attention from the most promising Wall Street reform proposals — including some tough-minded ideas from Hillary Clinton, so often accused of being a Wall Street toady.
The actual sources of the financial crisis have to do with risk and supervision. During the housing bubble, banks gave out terrible, un-pay-backable loans, whose risks were papered over through flawed bundling and misleading marketing; regulators didn’t have a good sense of where all those risks lay and how interconnected they were.
That’s partly because so much risk was concentrated in the “shadow banking” sector — that is, in financial institutions that aren’t commercial banks (think: Lehman) and historically haven’t been as closely supervised.
Dodd-Frank, passed in 2010, addressed some of these concerns. It created a council to monitor risk throughout the entire financial sector, including at shadow banks. But the law doesn’t go nearly far enough to regulate what the $14 trillion shadow banking sector can do, and under what conditions, to minimize the havoc it can wreak on the rest of the economy.
Clinton’s plan would essentially build on Dodd-Frank. She offers proposals aimed at increasing accountability, such as bigger rewards for whistleblowers. She’d impose a graduated “risk fee” on banks, which wouldn’t outright break them up but would discourage them from getting too big or, if they insisted on being big, taking too many risks.
Most important, she has laid out specific plans for more disclosure and oversight of the shadow banking sector.
Her proposals are not terribly sound-bite- friendly, as is often the case with careful financial regulations. That’s probably why they don’t get as much airtime as catchy, alliterative calls to “break up the banks.” Other presidential hopefuls nonetheless would do well to study them — and abandon their obsession with a dated law that has little bearing on today’s financial system.
Read more on this topic: