Clear as Glass

I worked for a major financial institution from 1990 to 2001 and were was therefore employed by such when Glass-Steagall was repealed. I believed at the time that the repeal was a mistake although I have to admit that my belief was more gut-level than intellectual. It simply seemed obvious to me that letting financial institutions get too big and do too many things was a recipe for disaster. While people who supported the repeal seemed to be arguing that agglomeration meant the losses from one type of business would be offset by gains from another, I worried about insurance losses crashing my bank or banking losses making my insurance worthless.

Then came the great financial meltdown of 2008 and some pundits began pointing the finger at deregulation, especially the Gramm-Leach-Bliley repeal of Glass-Steagall. Nonsense, replied other pundits. If anything, they claimed, the repeal of Glass-Steagall helped save at least some of the financial system enabling - for example - Bank of America to take over Merrill Lynch.

I don’t know how much the repeal of Glass-Steagall contributed to the current crisis. But I would just like to point out that both Bank of America and Citicorp* were beneficiaries of the repeal and I don’t think anyone would cite them today as shining examples of financial success. And so my gut is telling me that I was right all those years ago: the repeal of Glass-Steagall was a bad idea - although it was certainly only one bad idea among many over the last decade.

Why bring this up now? I’ve recently been reading through a lot of posts at MaxedOut Mama and ran across one that backs up my old gut feeling about Glass-Steagall (I’ve reproduced only bits and pieces - you really should read the whole thing):

... Wall Street argued with some passion and a lot of political cash that over time, the US economy was being disadvantaged by overly stringent regulation. ... I think one could fairly argue that over time, the reverse of the IB arguments were true - the regulatory constraints in our financial system prevented soaring to the heights, but over time fostered a healthy economic climate and sustained growth. ...

The result was that overall regulation was reduced, the incentives to verticalize were massive, counterparty buffers were eliminated, and within less than 10 years, the financial system imbalances that produced the Great Depression in the US had returned.

In the same post, MaxedOutMama also has a most interesting description of how things worked before and after agglomeration which demonstrates how the repeal of Glass-Steagall eliminated checks and balances that had existed earlier.

MaxedOutMama’s analysis was presaged by the October 2007 testimony of Robert Kuttner to the Committee on Financial Services of the U.S. House of Representatives, chaired by Barney Frank (via Anglachel’s Journal):

Since repeal of Glass Steagall in 1999, after more than a decade of de facto inroads, super-banks have been able to re-enact the same kinds of structural conflicts of interest that were endemic in the 1920s -- lending to speculators, packaging and securitizing credits and then selling them off, wholesale or retail, and extracting fees at every step along the way. And, much of this paper is even more opaque to bank examiners than its counterparts were in the 1920s. Much of it isn't paper at all, and the whole process is supercharged by computers and automated formulas. An independent source of instability is that while these credit derivatives are said to increase liquidity and serve as shock absorbers, in fact their bets are often in the same direction -- assuming perpetually rising asset prices -- so in a credit crisis they can act as net de-stabilizers.

Do read Kuttner’s entire testimony. It is a plea for intelligent regulation, reminding us that if the government is going to bail out entities it is wise for it to regulate their behavior in an attempt to avoid having to do so.

(I’m also struck by what both MaxedOutMama and Kuttner say about NRSROs (Nationally Recognized Statistical Ratings Organizations). It seems to me they dropped the ball big-time and yet I’ve read relatively little condemnation of their behavior. As Kuttner put it, “In this decade, it remains to be seen whether the bond rating agencies were corrupted by conflicts of interest, or merely incompetent.”)

So what conclusions do I draw from this other than that my gut often knows more than I do? Specifically that financial rules in place for 65 years shouldn’t be tossed aside lightly - which I suppose means I'm a conservative. Generally that hubris leads to nemesis - which I suppose means I'm a realist.

*****

*One of the theories floating around at the time was that Glass-Steagall was repealed specifically to allow Traveler’s and Citibank to merge; that they had announced their merger and dared Congress not to accommodate them.