Restore Glass-Steagall

Gerard Magliocca

Gerard N. Magliocca is the Samuel R. Rosen Professor at the Indiana University Robert H. McKinney School of Law. Professor Magliocca is the author of three books and over twenty articles on constitutional law and intellectual property. He received his undergraduate degree from Stanford, his law degree from Yale, and joined the faculty after two years as an attorney at Covington and Burling and one year as a law clerk for Judge Guido Calabresi on the United States Court of Appeals for the Second Circuit. Professor Magliocca has received the Best New Professor Award and the Black Cane (Most Outstanding Professor) from the student body, and in 2008 held the Fulbright-Dow Distinguished Research Chair of the Roosevelt Study Center in Middelburg, The Netherlands. He was elected to the American Law Institute (ALI) in 2013.

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7 Responses

  1. Matt says:

    To say that I’m not an expert on financial regulation would be too generous to me, but I found these comments on the topic fairly persuasive:

    http://thinkprogress.org/yglesias/2011/10/17/345217/glass-steagall-is-mostly-a-red-herring/

  2. Ken Rhodes says:

    Matt, I find those Yglesias comments most unconvincing, based as they are on this introductory paragraph:

    “But the rule that was repealed in the 1999 Gramm–Leach–Bliley Act were restrictions on the same holding company owning a bank and owning other kinds of financial companies. The thing about this is just that there’s really nothing in particular about co-ownership that you can point to as having been a problem in the financial crisis.”

    Goodness, what an interesting theory. Towne Bank is a local bank in the Hampton Roads area of Virginia where I live. For many years, Towne Bank simply did banking. They took in deposits and lent out the money to local home-buyers and businesses. They made a nice little profit by the simple banking procedure of paying less for deposits than they collected for loans. Each loan was evaluated by an in-house officer whose job it was to try to ensure that the funds would be repaid in a timely fashion, and that the price charged for the funds would exceed the price paid to the depositors.

    Now, however, Towne Bank has been disencumbered of the restriction to limit itself to banking. Thus, Towne Bank bought Prudential Decker Realty Company. So any mortgage loan submitted by a Prudential-Towne client carries a profit potential for the consolidated corporation far in excess of the profit on the loan, which has to be accrued over a long time. Now the approval of the loan is followed quickly by the *immediate* payment of the commission to the brokerage.

    Likewise, Towne Bank can now own an insurance company which sells insurance on the home loan. And life insurance on the buyer for the value of his mortgage. (And car insurance for the car which a car buyer bought using his Towne Bank car loan. …etc., etc., etc.)

    In somebody’s dream world, these conflicting objectives might not influence the officers of the bank to take previously unacceptable risks.

  3. Ken Rhodes says:

    A comment on the general subject of Glass-Steagall:

    The legislation passed in the aftermath of the crash of 1929 and the beginning of the Great Depression was not simply a bunch of partisan doodlers sitting around consulting with their lobbyists. The Pecora hearings were exhaustive, and exhaustively documented, and the legislation was a pretty effective way to get at, not simply the symptoms, but the causes.

    It worked for a long time. Banking was a boring, but extremely useful, part of the business picture in the USA for a long time. It didn’t usually attract the “best and brightest,” but it did fine at what it was doing, which was supplying the grease to the wheels of progress.

    Then some really smart guys figured out that there was lots more money to be made playing with money than there was in engineering, physics, and mathematics, if only they weren’t constrained by all those annoying regulations.

    The best thing that could be achieved by a reinstatement of the Glass-Steagall regulations would be to drive the “best and brightest” out of finance, which would no longer be either tons of fun or astoundingly profitable, and back into physics, math, and engineering, where their brain power could do some real good, and leave banking to the competent, if not brilliant, bankers.

    How’s that for a long, convoluted, and controversial sentence?

  4. Lemming of the BDA says:

    Here’s what I’m wondering about this, and maybe this is simplistic, but if it’s a question of once again banning bank holding companies from also owning investment banks, I don’t see what the point would be. I thought all investment banks were purchased, or converted to bank holding companies, as part of the 2008 panic?

  5. Ken Rhodes says:

    I think the idea is that “bank holding companies” are the problem. In the old days there were “banks” (which meant “retail banks”) and there were other types of companies, including insurance, real estate, and “investment banks,” which were totally different from retail banks.

    It’s retail banking that our economy relies on to provide liquidity to most businesses for everyday operations, and to most individuals for everyday money needs like car loans, small loans, and even mortgage loans.

    If the retail banks were divorced from all those “wholesale risk takers” then, presumably, the day-to-day economic activity of almost all of us could go on undisturbed even as the “big guys” discovered to their dismay that their house of cards was tumbling down.

    Not to mention, if the “wholesale risk taking” were divorced from the retail (including mortgage) banking, there would be far less pressure creating “bubbles.”

    Anyway, that’s the theory. The Pecora hearings certainly highlighted those ideas with substantial anecdotal evidence, and the subsequent divorce of retail banking from wholesale risk taking seemed quite effective for many years.

  6. Bruinrefugee says:

    As I understand the demise of Glass-Steagal, it had both a domestic and an international component to it. If I remember right, the pitch was that foreign (bankers?) did not have such restrictions and that the securities firms through a variety of routes were attacking the banks’ business via products that shaded into traditional areas.

    I’m moderately for reinstating Glass-Steagall, but it doesn’t really tackle the fundamental economic problems underpinning the financial crisis: what to do about the housing market.

    The S&L system blew up when interest rates increased in the ’70s; that blow-up led to the tax changes that turned S&L’s into the driving force for junk bond sales through the artificial market for devalued real estate assets as S&L’s tried to save their cash flow positions by aggressive financing steps in the ’80s; the tapping of outside cash to try and escape the S&L mess and to meet the perceived potential capital shortfall to finance housing for the boomers (heavily encouraged/financed/lobbied for by the GSEs) gave us RMBS and CDOs and the rest.

    There’s blame to go around, but the financing of house purchases has roiled the country for more than 30 years.

    Combined with the lack of transparency in the financial companies exposures and the agency problems all up and down the line, the consolidation allowed by Glass-Steagall probably contributed somewhat to the risk, but it’s probably a smaller piece.

    While we now have to worry about banks that are “too big to fail” it was a nominal “insurance” company — AIG — whose potential failure threatened to take down all the financial markets. And part of the reason the banks are so big now is that they already had the resources — presumably in part because of the death of Glass-Steagall — in 2007/2008 to purchase the dead-men-standing investment banks.

    That said, without a wholesale revision of how we approach the very concept of home-buying, I don’t see how banks can be divorced enough from both the risk of bubbles and competition. If they can’t operate in other lines of business all those nominal “deposits” go away while the stocks themselves would be under great pressure. And there’d still be the great risk of another interest-rate inversion like the one that killed the S&Ls, esp. if that’s compounded with the mark-to-market rules.

    Now that was long and rambling…

  7. jpe says:

    @ Ken: every bank has always been owned by a holding company. Glass Steagll was about restricting the lines of business that the holdco could engage in.

    re: GS: it doesn’t seem that GS-compliance determined the winners and losers during the crash. If the victims had all been diversified financial holding companies (banks w/ non-banking subs), then that’d be good per se evidence that GS should be brought back. But a number of financial holding companies came through it pretty well (JPMC, Wells Fargo), while a number of traditional banks collapsed (WaMu, notably).

    re: Ken’s example of the mortgage realtor: I’d think that banks could always hole mortgage realty companies. The test under G-S was whether a line of business is sufficiently connected to traditional banking, and mortgage realty certainly would seem to be. I’d be shocked if banks couldn’t engage in that line of business under G-S (just like they could sell mortgages to securitizers, buy and sell real estate related derivatives, and so on).

    As a side note, we’re the only OECD country that’s ever had that sort of firewall between financial sectors.