[corp-focus] Reflections on Glass-Steagall and Maniacal Deregulation

[robert weissman]

Reflections on Glass-Steagall and Maniacal Deregulation
By Robert Weissman
November 12, 2009

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expectation that Glass-Steagall would be repealed.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.


Robert Weissman is president of Public Citizen, <www.citizen.org>.

(c) Robert Weissman

This article is posted at: 
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