The repeal of Glass Steagall itself did not cause the financial crisis. However, the repeal did help make the crisis worse.

I bring this up because there has been a series of straw man articles claiming Glass Steagall was not a cause in the crisis. This misstates the impact and the broader context. The overturning of the successful 1933 legislation was part and parcel of an ideology that WAS a major factor in the crash: The erroneous belief system that banks can self-regulate. This manifested in a variety of bad ideas, poor oversight and worse legislation.

The finacialization of the American economy allowed banks to become bigger, more complex, and greatly leveraged. When it all came down, the crisis was broader, deeper and more dangerous than it would have been otherwise.

Glass Steagall’s repeal, after 25 years and $300 million worth of lobbying efforts, culminated decades of radical deregulation.

New-fangled derivatives? No oversight, reporting, or reserves necessary, courtesy of the Commodities Futures Modernization Act of 2000 (CFMA). You can thank Enron Board Member Wendy Gramm, and her Senator husband Phil Gramm, for that one. Subprime-Lend-to-sell-to-securitizers business model? Those are the financial innovators! At least, that is what Alan Greenspan called them, and why he refused to oversee them as Fed chair. Rules on SEC leverage? Let’s create a special exemption from the law for just 5 investment banks.

And so on. The list of radical deregulation and false beliefs is long and painful and dangerous and costly.

Of course “reputational risk” would serve as a deterrent to poor decision making! No bank would ever behave so recklessly as to put their own hard won status on the line — forget their very existence.

How’d that idea work out?

Had Glass Steagall not been repealed in 1999, we would still have had a financial crisis. Ultra low rates, the abdication of lending standards, the Commodities Futures Modernization Act of 2000 (and other acts of idiocy) all made sure of that.

With Glass Steagall, there would not, could not, have been a Citi/Travelers merger, and competitors would not, could not have bulked up the way they did. Major money center banks most likely would have been smaller, more manageable, more easily wound down. Arguably, too big to fail might not have been the rule, and bailouts might not have been necessary. This is, of course, mere supposition.

The misguided philosophy that led to the repeal of Glass Steagall also did contribute mightily to the crisis. The radical deregulatory philosophy from fools such as Alan Greenspan and Phil Gramm was certainly a major factor — and the Glass Steagall repeal was part of that continuum of bad ideas.

~~~

What we should be discussing are the corrupting influence of crony capitalism and radical deregulation; instead, we find ourselves forced to defend capitalism and free markets. We should be finding ways to definancialize the US economy, and reduce the influence of bankers.

 

Previously:
Volcker: Reinstate Glass Steagall (September 24th, 2009)

Gramm: Glass Steagall Repeal Irrelevant (November 19th, 2009)

What’s Wrong? The Deregulators (April 8th, 2011)

A Brief History Lesson: How We Ended Glass Steagall (May 17th, 2012)

See also:
Breaking Up Is Hard to Do (WSJ, July 27, 2012)

Let’s shatter the myth on Glass-Steagall (WaPo, July 28, 2012)

Category: Bailouts, Legal, Really, really bad calls

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

22 Responses to “Glass Steagall Repeal Made Crisis Worse”

  1. VennData says:

    Except everywhere else in the world banks are supermarkets of insurance, ibanking, trading etc. …and always have been. So no, that can’t be it. They were simply allowed too much, way too much leverage.
    And there is this laziness in the customers, the people who bought CDOs and CDSs and the like gorged upon these leveraged products masquerading as safe, high yields. You can’t as a fund manager, be sitting there with 30% of your assets in a leveraged bet on real estate, no matter how much you want to believe that RE ‘always goes up.’
    Where are the customer’s yacth,s, those MBAs who manager wealth? …you may ask…. The money managers of pensions, endowments, and all this many pools of capital are too dumb to run them and too greedy to put all their assets into indexed products since then, eventually, their boards would ask why the managers get paid so much. So they do lots of dumb things. Like buying complex bank products.

    ~~~

    BR: They were not always supermarkets — THAT is what the GS repeal changed

  2. [...] Barry: Yes, Glass-Steagall's repeal did in part lead to the financial crisis.  (TBP) [...]

  3. ConscienceofaConservative says:

    When we contrast the failure of a Bear Stearns or a Lehman (investment banks) versus the repeated failures of a Citigroup in the 80′s, 90′s and most recently around 2008 we need to consider how the policy responses have been quite different on the part of regulators and how much more at risk tax payer dollars were. Glass Steagall is not about preventing failures, but about systemic risk and tax payer exposure. And in some ways Glass Steagall represented less not more regulation as a pure investment bank or hedge fund is subject to less scrutiny than a combined commercial/investment conglomerate.

    ~~~

    BR: How many banks have been saved repeatedly? Citi is an outlier, not the rule.

    Citi proves that banls should be allowed to fail instead of being repeatedly bailed out. It does not prove Glass Steagall repeal was not misguided. (sorry bout the double negative)

  4. super_trooper says:

    Moreover, an intact Glass Steagall act would have prevented mergers of institutes such as BoA and Countrywide etc in response to the crisis. Many of these companies (countrywide etc) would have been forced to go bankrupt rather than sink what could have been “reasonably” healthy banks.

  5. cpd says:

    I agree with your points about Glass Steagall. If I had to pick one thing that was most responsible for the financial crisis, it would be the appointment of Greenspan to run the Fed. We would have got a substantially different result if someone more similar to Volcker had been appointed. Greenspan was the master at blowing financial bubbles with cheap money and leverage. And he lit a fire under it with his mindless focus on de-regulation. I have read a number of articles about his history before the Fed. He had a very poor track record and it’s mind boggling how someone like him could end up running the central bank. I am absolutely convinced that he is public enemy number one for our broken economy.

  6. VennData says:

    If I had to pick one, it was ‘Ownership Society …that mis-named law that let US banks leverage at 50 to one.
    eventually, 50 to one leverage will result in a margin call. No matter what you are investing in.
    It did.

  7. ConscienceofaConservative says:

    BR: How many banks have been saved repeatedly? Citi is an outlier, not the rule.

    Citi proves that banls should be allowed to fail instead of being repeatedly bailed out. It does not prove Glass Steagall repeal was not misguided. (sorry bout the double negative)

    Response:
    You misunderstand me. If We had Glass Stegall back Citi would be tamer and smaller. Less risky activities and smaller size, which would either prevent bad behavior and if not permit it to fail. Citi proves why we need Glass Stegall.

  8. denim says:

    “What we should be discussing are the corrupting influence of crony capitalism and radical deregulation; instead, we find ourselves forced to defend capitalism and free markets. We should be finding ways to definancialize the US economy, and reduce the influence of bankers.”

    Let’s be fair and discuss, attack, and defend them all if they are good.

    Crony capitalism.
    The most egregious acts are the states stealing one industry from another. The granting of special tax treatment to companies, even zeroing taxes out, when other businesses and all employees must pay for the deficit created needs to be stopped.

    Radical deregulation.
    As we have seen, companies cost shift and consider fines merely a cost of doing business. Human values have to be legislated into being because the company is expected to be a conscience free sociopathic entity according to some current business trainers and pundits.

    Capitalism.
    Freedom to start an enterprise and not be attacked by existing companies and monopoly power is old time capitalism. Ayn Rand’s type of capitalism is straight from hell and needs to be sent back.

    Free markets.
    OK. The minimum price in a free market is zero. The exuberance of the bidding process is all that supports the minimum price. While that may be great for electronic toy-gadgets, a minimum price support mechanism is desirable for some things we hold to be dear. A home is a good example of something dear we should consider have minimum price supports on. Otherwise, in a panic, the bankers will drive the value of houses down by dumping foreclosed homes on a depressed market. While bailing the banks saved the bankers bonus and all, the same money could have been used to support the price of the houses themselves by having the government buy the foreclosure at say the original purchase price and “warehouse” it until the panic subsided.

    Risk insurance derivatives
    It is insurance and should be regulated like insurance and sold only by licensed, audited, and fully capitalized, insurance companies.

  9. Glass-Steagall, or not, is a ‘Red Herring’..

    rather, more Systemically, the Federal Reserve’s Role, as well as Its very Existence, should be Questioned..

    the existence of the FDIC, also, play(-s/-ed) a huge Part..
    ~~

    “The Lender of Last Resort”-Canard has been well-played..The American Public, and TROW, have been stuck ‘Paying the Piper’..

  10. Seaton says:

    Well-put, BR, nice rebuttal to Pearlstein’s P.O.S. “schmoozing-spin” to calm the masses. Misdirection at it’s finest. So, BR, when will Americans—if not indeed the world—insist this Robbery by Those-That-Can-&-Did-&-Do (as opposed to the spin of “Too-big-to-fail/too-big-to-manage”) will be undone by the pitchforks & torches crowds, through increasingly-possibly-suspect elections? Hmmm…

  11. Stirling says:

    That there will be another market sell off is a metaphysical certainty. That there will be one that takes the real economy with it was not. The economic collapse came because policy makers were trying to fend off the results of a financial crisis and protect its players. Someday a book will be written entitled May 2008: the month the 20th century died.

    I believe in separation of investment banking and retail banking with the same fervor, and for essentially the same reason, I believe in the separation of Church and State.

  12. CB says:

    Good points BR – also the financial lobbyists won in 2005 and passed the Bankruptcy Abuse Prevention and Consumer Protection Act. The title sounds reasonable right? No politician could be against preventing abuse or protecting the consumer? But the details beyond the title mostly did just the opposite – favoring the financials and creating debt slaves of “we the people” –  especially student loan debt. 

    Most laws are passed with this method of obfuscation –  the Commodity Futures Modernization Act that kept derivatives unregulated, The Financial Services Modernization Act that repealed Glass-Steagall, or the 2000 Agriculture Risk Protection Act that enriched big insurance companies and transfered more risk to taxpayers.   

    How does it feel to be MODERNIZED and PROTECTED by the corporatocracy?

    Can we at least admit deregulation was basically a FAILED BELIEF SYSTEM? Even Sandy Weill now admits banking deregulation was a mistake.
     
          
     

  13. [...] The Big Picture, Barry Ritholtz drives home the point that the repeal of Glass-Steagall made the market crisis of 2008 markedly worse that it would have otherwise [...]

  14. Rick Caird says:

    All is well. We have replaced Glass- Steagall with Dodd-Frank. What could possibly go wrong?

    ~~~

    BR: I wouldn’t use the word “replaced,” I would go with “downgraded” — we used to have an effective regulatory regime, now we have complex ineffective one.

  15. VennData says:

    BR: They were not always supermarkets — THAT is what the GS repeal changed

    But most everywhere else in the world, it works. It doesn’t work here when you allow banks to leverage at fifty to one.

  16. DeDude says:

    @CB

    Yes isn’t it amazing that the business bankruptcy abuse that was a real problem was not fixed, but the consumer bankruptcy abuse was (even though it was not a real problem).

    I guess we are just monkey in suits. When the big alfa monkey rob us we accept it as part of life, nothing we can do about it. But if the lowly delta monkey takes something from us, we are outraged (because it is not just the loss from being robbed but a challenge to our status in the hierarchy).

  17. VennData says:

    Bear, Lehman, AIG the main problems weren’t banks. Having multi product banks didn’t hurt Canada.

  18. DeDude says:

    @VennData;

    You forgot Citi. If the multi product banks are tightly regulated then they don’t become a problem, because they are a lot less likely to ever get into trouble. But if you want to be American and leave financial institutions lightly regulated then they have to be small and disconnected in size and function so that when they blow themselves up there isn’t a lot of important stuff nearby that will suffer collateral damage.

  19. Ingolf Eide says:

    “The erroneous belief system that banks can self-regulate.”

    Undoubtedly true if there’s implicit or explicit government support. Wherever financial institutions don’t have to face the full consequences of their actions, then very strict regulation is essential. That’s doubly so with fiat currencies and with central banks ready to top up the monetary base whenever needed (and often when not).

    Still, unlikely though it is that we’ll ever see it again, it’s perhaps worth noting that free banking worked well in a number of extended periods, including Canada in the late 19th and early 20th centuries. In each such case, the currency was specie based and banks were subject to minimal special regulations.

  20. AtlasRocked says:

    “The big lie is that allowing capitalism to function without any oversight whatsoever will lead to a flawlessly functioning machine”

    No capitalist believes this, this is a big lie.

    Capitalism is a series of small failures over and over and over that weed out bad ideas. Simple rules are adopted by the participates to keep each market healthy, but 100% health is never reached. the rules have to be refined and tried out again and again.

    When “less free” markets are tried, the less the number of decision makers, the more the risk of following one giant mistake. The US is centralizing most of it’s economic policy, using borrowing and money printing to grow the economy, instead of letting bad legislation be exposed and destroyed with better rules.

    The worst we thing we could do when the greenspan/b.franks/clinton/paulson ideas failed was to bail them out. worst possible idea. That combined the worst ideas of a freer market with the very worst idea of a centralized market: bail out the bad ideas. We have to let bad ideas fail and push the failures on the advocating actors and companies.

    ———————————————-

    Here are some other much bigger problems: Here are the big ommissions of critical data the public is not seeing.

    1. Marginal tax rate increases correlate with larger debt in 95% of the cases in the G20. Tax increases manifest a terrible record of debt reduction, nearly a total failure in practice. Every nation with higher tax rates than the US has MORE debt except 1, and it is catching up fast (Canada). A tax increase can be said to be certain to result in more debt.

    (that doesn’t mean I’m against tax increases – just don’t think they work w/o a balanced budget amendment.)

    2. Policies to provide more social benefits are failing to produce revenue to pay for the programs, trending opposite. New benefits programs are bankrupting old, proclaimed “vital” benefits, like Social Security. Two liberal policy advocates I recently spoke with said let Social Security die provide health care instead. Wow. Contrarily, in the 1960s everyone in America got health care and it was 100% affordable. No medically related debt existed for the US government Then.

    3. Policies to “heal” and “grow” the economy through gov’t “stimulus” are resulting in growth 1/5 of the rate of money borrowing: Borrowing 10% of the GDP is producing 2% growth. We need at LEAST 5x, for payback

    4. Keynesian spending has a ZERO percent success record, it has NEVER produced payback revenue.

  21. AtlasRocked says:

    A burlesque presentation of the debt problem. Maybe some of the people not listening will listen to this.

    http://www.youtube.com/watch?v=GXcLVDhS8fM&feature=player_embedded

  22. [...] Ritholtz makes a very good point about the claims that repealing Glass-Steagall did not cause the financial crisis. Glass-Steagall [...]