Regulatory Rumpus: The Battle Over Reinstating Glass-Steagall

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Among the small number of Americans who are passionate about financial regulation, no topic raises hackles more than the so-called Glass-Steagall act. It is “so-called” because when you hear the term “Glass-Steagall” the speaker is most certainly referring to four provisions from the Banking Act of 1933, which was sponsored by Senators Carter Glass and Henry Steagall. The four provisions in the law popularly referred to as “Glass-Steagall” banned deposit-taking institutions from dealing in securities for their own profit, and it banned firms primarily focused on securities-dealing from taking deposits.

Ever since the financial crisis, there has been a debate over whether the repeal of these provisions through the 1999 Gramm-Leach-Bliley Act contributed to the financial crisis. And this five-year-old debate was rekindled last week when Senators Elizabeth Warren, John McCain, and Angus King introduced a “21st-century Glass-Steagall Act,” which would actually be more strict than it’s 80-year-old predecessor. Because the provisions of the original law were weakened over the years through successive interpretations by the Federal Reserve, the language of the newly proposed legislation is much more clear cut: Deposit-taking institutions would simply not be able to do the sorts of things we traditionally associate with investment banks, like buying and selling securities for profit, underwriting the issuance of stock or bonds, or acting as an investment adviser.

(MORE: Regulators Finally Start Standing Up to Big Banks)

There are many folks who feel this legislation is a distraction from the difficult task of making our financial system safer. As Matthew Klein writes for Bloomberg View: 

There is a myth, popularized in part by inane television programs, that the 1933 decision to separate commercial banking and investment banking made the financial system safe and promoted decades of prosperity. According to this false narrative, the financial system was just fine until the government decided to repeal the Glass-Steagall Act of the early 1930s in 1999. This allegedly empowered unsavory securities dealers to gamble with customer deposits, or something.

People who believe this story think that the 2007 crisis would never have happened if the wall separating commercial and investment banks had remained intact. Similarly, they also believe that future crises can be prevented by enforcing a hard separation between “boring” banking (mortgages, loans to businesses, etc.) and “dangerous” banking (everything else, especially derivatives trading)

But this narrative ignores the fact that banking, even the boring variety, is inherently risky. Most people’s concept of a “boring” bank is a local savings and loan, one that borrows money for short periods of time (by soliciting deposits from customers) and lending for long periods of time, typically in the form of mortgages. But as the savings and loan crisis of the 1980s showed, this sort of business can get very risky, very fast in an environment of rising interest rates. In other words, dumb bankers don’t need derivatives to go belly up.

Furthermore, the high-profile bank failures that are associated with the financial crisis were not the full service “super banks” that were involved in both commercial and investment banking. They were either strictly investment banks, like Lehman Brothers and Bear Sterns, commercial banks like Washington Mutual, or mortgage banks like Countrywide (which was ill-advisedly bought by Bank of America in 2008). So why exactly are we spending time trying to reinstate a rule that, if it were in effect in 2007, wouldn’t have prevented the meltdown?

Supporters of the proposal like economist Simon Johnson argue that this analysis misses the point. Just because one reform wouldn’t by itself have prevented the financial crisis doesn’t mean that the reform wouldn’t, on balance, improve the nation’s financial system. He points to the example of Citigroup, which because of the erosion of Glass-Steagall protections was able to grow to such a size that the U.S. government had no choice but to bail it out once the financial crisis hit. In other words, Glass Steagall would be most useful in fighting the “too big” part of “too big to fail.”

(MORE: Are Banks Bluffing About the Danger of Banking Regulation?)

FDIC Vice Chairman Thomas Hoenig jumped into the fray yesterday with a letter to Politico arguing that even though investment banks like Lehman Brothers and Bear Stearns weren’t “deposit taking institutions” in the technical sense, they did serve the same role as traditional banks by offering short-term debt products like “repurchase agreements” and money-market mutual funds. The over-reliance on these short-term debt instruments — which were often marketed to be as safe as bank deposits — was one of the main triggers of the financial panic. Hoenig argues that investment banks’ reliance on these instruments was motivated out of a need to compete with behemoths like Citi, which because of the repeal of Glass-Steagall, were able to obtain cheap funding through traditional bank deposits.

Opponents of the new bill fire back that, while an updated Glass-Steagall might make the financial system safer by making banks smaller, it isn’t the most efficient way to downsize the banks or protect against bank runs. Federal Reserve Governor Daniel Tarullo, for instance, argues that simply regulating these instruments more strictly, combined with efforts to require larger banks to finance themselves with less debt, would be more effective than bringing back Glass-Steagall.

To me, there’s dark comedy in all this indignant debate over the relative merits of various financial reform proposals given the present political climate. In recent months, various lawmakers have proposed hard caps on bank size; rules that would force banks to rely on much higher equity funding; and proposals that would separate commercial and investment banking. Any of these reforms would make the financial system safer, yet none of them have gained enough momentum in Washington to become law. It appears, then, that reform advocates are taking a throw-everything-against-the-wall-and-see-what-sticks approach — and reform opponents are taking a indiscriminating reject-everything-out-of-hand approach.

But as last year’s drama over the proposed SOPA and PIPA laws proves, it’s difficult to tell which proposed reforms will capture the public’s imagination and which won’t. If Elizabeth Warren is able to use her stature to gain public support for a new Glass-Steagall, then it would be silly to oppose the reform simply because it isn’t a silver bullet.

(MORE: The Break-Up-the-Banks Drumbeat Gets Louder. But Is It Just a Bunch of Hot Air?)


 Hi Christopher,

We need to look no further than the banks preparation for the Volcker rule in order to understand how there will always be a percentage of bad players that seek to find ways around regulation instead of seeking to comply with the spirit of regulation.

As outlined by PwC in their regulatory brief  there are three types of banks....those that are waiting for a sign, those that are finding faith and others that have found religion and have converted with well defined governance structures.

The good news here is that most banks are moving toward full compliance, or at least their interpretation of full compliance. That said, a number of large global players are taking a "wait and see" attitude, relying instead on lobbying and other efforts to dilute the impact of any industry regulation. The bad news is that most banks, even those seeking full compliance have yet to implement the required technology changes in their infrastructure. (

 We can only hope that the various regulatory bodies involved in developing banking regulations (OCC, Fed, CFTC, SEC, FDIC) will be able to issue final rules at some point in 2013. We all need to also hope that pragmatism will lead to an executable approach that tightens liquidity requirements, addresses the treatment of sovereign debt, sets an elevated compliance threshold and clarifies relevant metrics and the period of time banks have to achieve conformance.



Yes, while Michael Lewis would argue that investment banking was ruined as soon as they started playing with OPM (other people's money), most people understand that you can draw a pretty straight line between the end of Glass-Steagall and the trillions of dollars poured into the financial system by the US Govt/Former Goldman Officers. 

You can't build an argument on a false premise, and the idea that the good 'ol savings and loans went kaput all on their own fails to take note of the two Congressional moves (Monetary Control act of 1980 and the Depository Institutions Act of 1982) that deregulated the S&L's, giving them the tools to cut their own wrists. 

The financial services sector does not exist for profit alone. The banking part of it, at least, is supposed to "serve" the public by safekeeping deposits and funding local businesses. But the profit profile of the banking sector is so high these days that they have to take major risks in order to achieve the target returns. This means, among many results, that we have tens of billions of dollars put into "payday loans" instead of small business loans because the banks need the higher return. 

It does seem as if everything is thrown against the wall. The problem is that any financial regulations will have to overcome the $100M+ spent every year by the financial services lobby to keep out any and all regulation. The bankers, they like playing with OPM. Whether that's stockholders or taxpayers. They don't want that to change.