Last week, I referenced the Warren-McCain bill to restore Glass Steagall. Earlier this morning, we showed Senator Warren discussing the bill on CNBC.

The Squawkbox anchors revealed such a shocking ignorance of history, that we are compelled to offer a brief refresher on what Glass Steagall does and does not do. (Kudos to Senator Warren for her patience in explaining the basics to this crew of ideologues).

Our refresher: Glass Steagall is the Depression era, post-1929 crash legislation that cleaved in two the major fields of banking. Some folks have found it easy to conceptualize the split as dividing banking into “Main Street” and “Wall Street,” so for simplicity, we shall as use that divide to explain the legislation’s purpose.

Your basic, Main Street banking — depository accounts, savings, checking, loans, mortgages, etc. — is one half. These are the institutions that have FDIC insurance guaranteeing the safety of your deposits. What this means in actuality is that the taxpayer is ultimately on the hook for any bank failures that lead to depositor losses. If the FDIC insurance pool ever gets exhausted, you and I have to pony up the Do-Re-Mi. Late in 2008, it looked as if that might occur, but a 2009 increase in FDIC insurance fees — and of course the bailouts — prevented that.

On the other side of the banking street is the more speculative kind of financial engineering that Wall Street does: Trading, Underwriting, M&A, Investing, Syndication, Asset Management, IPOs, etc. These all involve pools of capital (other people’s money), greatly increased risk, higher potential returns, and the possibility of losses. As we saw in 2008-09, the possibility of catastrophic loss that can wipe out entire companies also exists.

The reason for Glass Steagall was to create a firebreak between the two forms of banking.

Why was a firebreak needed? The spillover effect from the Wall Street crash on to Main Street was brutal. Recall back in the 1920s, home mortgages were 3-5 year interest-only forms of credit, with a balloon payment at the end. Home owners and Farmers either rolled their mortgages over, or sold the property and paid them off. What happened post-1929 crash was that many Main Street banks had lost most of their access to capital, courtesy of the collapse of Wall Street banks. Most linbes of Credit dried up. The Great Crash of 1929 led directly to a massive foreclosure surge in the 1930s, far worse than anything we experienced after the 2006 housing peak. Some estimates for NYC RE were a failure rate of 60% or worse. The rest of the country similarly suffered from the loss of ordinary, regular credit, the lifeblood of any modern economy.

It went far beyond mortgages. Operating capital for business dried up, industrial production collapsed, unemployment skyrocketed. All of these effects were DIRECTLY attributable to the conflagration having nothing standing between the Wall Street caused market collapse and the freezing of credit on MainStreet.

Hence, the firebreak. As I described in the Washington Post last year (Repeal of Glass-Steagall: Not a cause, but a multiplier) the shortage of lifeboats on the Titanic did not cause it to sink, but it sure as hell raised the body count. The repeal of Glass Steagall had a similar effect. It did not cause the crisis, but lack of a firebreak allowed it to jump easily form Wall Street to Main Street.

In prior discussions, we have discussed the many causative factors that led to the crisis. The repeal of Glass Steagall was not one of the factors that was a direct underlying causative element. There is no doubt that its repeal allowed the credit crisis to expand faster, wider and have a greater impact than if that firebreak still existed. That is why the list of supporters for bringing back Glass Steagall includes more than just Senators McCain and Warren — former FDIC chair Sheila Bair and current FDIC Vice chair Thomas Hoenig, former Federal Reserve Chair Paul Volcker, even former Citigroup CEO John Reed.



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

Glass Steagall Repeal Made Crisis Worse (July 30th, 2012)

Repeal of Glass-Steagall: Not a cause, but a multiplier (July 5, 2012)

Senators Introduce Bill to Separate Trading Activities From Big Banks  (NYT, July 11, 2013)


Category: Bailouts, Really, really bad calls, Regulation, Television

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.

26 Responses to “A Brief Refresher on Glass Steagall”

  1. Liquidity Trader says:

    ideological #fucktards

  2. rd says:

    A certain percentage of Wall Street financial artists are essentially suicide bombers.

    They should be allowed to blow up their own finances in a big open field away from everybody else so that they do not create collateral damage.Glass-Steagal afforded them that right.

    However, we should not allow the big financial institutions that receive numerous government-granted profit generating functions to self-immolate in a crowded marketplace. This is especially true now that we have actually officially labelled them as Too Big To Fail, so they get actual government guarantees as well as government granted rights, such as Treasury Direct Dealers, access to Fed discount window etc.

    • Usually the suicide bomber dies in the attack (hence the name SUICIDE BOMBER); We were not so fortunate …

      • VennData says:

        And their dad introduced the financial artist to a banker, or some hybrid like an AIG swap salesmen.

      • rd says:

        They tried to kill themselves financially, but the TARP and Fed EMTs rushed to the scene and saved them. I don’t think there will be as many medics rushing to save them the next time they set their financial bombs off. the big question is whether or not Dodd-Frank will have kept enough of them out of occupied public spaces to mitigate the collateral damage.

        MF Global should be another recent warning sign that these folks are bound and determined to take themselves and anybody doing business with them down in their dreams of wealth and glory and will override basic sound principles in order to do so.

      • manifest says:

        Conjures an image of a certain Bank Czar collecting parachutes when sending these parasites out for their Final Mission. Keep Hope alive!

  3. Petey Wheatstraw says:

    ” The repeal of Glass Steagall had a similar effect. It did not cause the crisis, but lack of a firebreak allowed it to jump easily form Wall Street to Main Street.”

    All the fuel for the fire was on Main Street, and the fire was determined to keep burning — brighter and hotter than ever. The fire might not have a conscience, but that doesn’t mean the people of the town had to be stupid enough to remove the barrier that protected themselves from it.

    In another analogy, if we remove all of the painted lines and signs from our highways, that, in itself, will not be the proximal cause of the ensuing traffic accidents, but we’d be fools to do it.

    • I disagree — Main Street was but the tinder. The fuel came from Wall Street — via phony ratings by Credit Rating Agencies (Moodys and S&P), the securitized subprime paper, the sheer leverage and recklessness.

      Main Street was consumed in the fire, as Wall Street kept pouring on fuel!

      • Petey Wheatstraw says:

        Maybe so, BR, but I still think that the subprime paper, phony credit ratings, etc., were part of the fire, itself. If main street hadn’t been a tinderbox ready to be consumed, no firewall would have been needed — the jackassery would have burned itself out, with the damage confined to the great wilderness of “financial innovation.”

        BTW: The fire department (regulatory agencies), still says they can’t do a thing about the fire, as they deny its existence. Shorter: “What fire?”

      • m.jed says:

        By the time the crisis hit, the Main Street banks were dependent upon derivatives regardless of the existence of Glass-Steagall. Countrywide was an “originate to sell” model, as was WaMu. Bear and Lehman inventoried the MBS derivatives. This was a deverticalized paradigm that was compliant in a pre-Glass-Steagall world.

  4. Michael M Thomas says:

    in Chernow’s big book on Morgan and found on pp.354-55 I found this great exchange in the summer of 1932 (before the election) between Leffingwell of Morgan and FDR:

    “…You and I know,” (wrote Leffingwell,) “that we cannot cure the present deflation and depression by punishing the villains, real or imaginary, of the first post war decade, and that when it comes down to the day of reckoning nobody gets very far with all this prohibition and regulation stuff.” To which FDR replied: “I wish we could get from the bankers themselves an admission that in the 1927 to 1929 period there were grave abuses and that the bankers themselves now support wholeheartedly methods to prevent recurrence thereof. Can’t bankers see their own advantage in such a course?”

    And then Leffingwell again: “The bankers were not in fact responsible for 1927-29 and the politicians were. Why then should the bankers make a false confession?”

    • 873450 says:

      “I wish we could get from the bankers themselves an admission that in the 1927 to 1929 period there were grave abuses and that the bankers themselves now support wholeheartedly methods to prevent recurrence thereof. Can’t bankers see their own advantage in such a course?”

      The great tragedy of Obama’s presidency was his wholesale buying into a “wish” mused by FDR knowing it was fantasy.

  5. constantnormal says:

    Readers should recognize that Barry has limited himself to only the aspects of the Crash of ’29 and the ensuing Great Depression that Glass-Steagall addressed.

    There were also things like “bucket shops”, and mutual funds (sold to the public by banksters like Goldman Sachs) that possessed only a name, with no underlying securities, and a host of other things that make our current fiasco look tame in comparison. If anyone wants to see the full scope and grandeur of the economy and Wall Street prior to 1929, I recommend J. K. Galbraith’s “The Great Crash, 1929″.

    Unregulated/unrestrained capitalism plays by no rules — whatever it takes, get the money from anyone/everyone else’s hands into your own. While there are certainly inept regulations, and occasionally over-regulation, the absence of regulation is far worse, as it is easier to fix broken regulations than it is to devise and impose regulations of any sort on the unregulated.

    • rd says:

      I have always been baffled that the same crowd pushing for complete deregulation of financial markets also vote for Three Strikes laws that throw people in jail for decades for getting caught a few times with dime bags of weed.

      Apparently, wealthy people wearing suits are incapable of committing crimes and misdeeds but poor people in jeans do so as a matter of course.

      • Frwip says:

        To many, wealth is a sign of godliness. It’s the old Calvinist strain, still running strong.

        So, indeed, in the views of this crowd, wealthy people wearing suits are incapable of committing crimes and misdeeds.

  6. Moss says:

    What Warren also pointed out is that the main TBTF mega banks are now much bigger posing an even greater risk when the next crisis appears. If anyone thinks that Dodd-Frank with the idiotic living will wind down plan will work then you also believe that Goldman is doing God’s work. The only thing the banks care about is the next quarters profit and thus the bonus pool. The banks are opaque compensation and political donor conduits siphoning off every dollar from whoever they can.

  7. [...] banking system. Senator Warren, CNBC, Feasting on the Squawk Box Hobbitses, here. CNBC folks make The Big Picture appear rational and well thought [...]

  8. constantnormal says:

    Barry, do you know if Senator Warren’s legislation would allow swaps usage in the depositor-protected sides of the banks? I can easily envision banksters using swaps instead of the conventional sources for parking overnight deposits, garnering a few more basis points of yield, with the added potential for surprise blowout gains (as well as the other kind of surprises) … putting depositor monies into anything that is not subject to audits and inspection strikes me as simply nuts.

  9. ironman says:

    A contrary view, from elsewhere in the econoblogosphere:

    I am puzzled by the renewed demand for the return of Glass-Steagall. I am puzzled not because Glass-Steagall might be bad policy but because it is so clearly a policy that doesn’t deal with the problems that created the financial crisis. If one had to sum the crisis up in one sentence it would be hard to do better than “a run on the shadow banking system.” The shadow banking system is that collection of mostly non-bank financial intermediaries who base their credit creation not on deposits but on repo, money market funds, SIVs, asset backed securitizations and other financial structures. The big new fact that I learned from the financial crisis and that I thought someone like Elizabeth Warren would surely also have learned is that the shadow banking system is larger than the regular banking system.

    Separate commercial and investment banking? Please. The problem was that investment banking, in the form of shadow banking, become so separated from commercial banking that the Fed no longer had any idea where a majority of credit was being generated. Credit creation separated from banking as understood by the Fed and moved into the shadows, hence, the term shadow banking.

    [Brief discussion of alternative options for addressing the shadow banking issue...]

    Now whether you think Gorton-Metrick or Kotlikoff ideas are good ideas, and I am not arguing for either, these ideas at least addresses the important issues. In contrast, Glass-Steagall would merely shuffle around organizational boxes in the less important regulated banking sector. Indeed, why would anyone think that 1930s policy is the solution to a 21st century problem?

    Most likely, the 1930s policy provides more opportunities for political graft

    • Ever since I read Tyler Cowens article claiming Predatory Borrowing The Bigger Problem I was forced to place him & Marginal Revolution into the broad category of deeply ideological and therefor suspect. Economics is rife with these sorts of ideologues.

      Of course Tabarrok is perplexed by Glass Steagall. Effective regulation is not part of his narrative . . .


  10. formula57 says:

    A decent analysis of GS is given by Frances Coppola in her blog – – that states that as central bank liquidity support would be necessary for Wall Sreet as for Main Street banks, today any regulatory separation is an illusion so far as a firewall is concerned.

    • DeDude says:

      What Coppola fail to comprehend is that just because the separation does not cure any and all ills does not mean that it would not cure some of the problems. Yes if a regular bank with 10x leverage has 20% of its deposits from the iBank and shadow banking system, and those collapse, then that bank could experience a “run” beyond what it could handle. However, the public bailout would be limited to $250K for each shadow and iBank entity that were costumers of that bank. In all likelihood the only people losing money over the week-end of FDIC “reconstruction” would be shareholders and those shadow and iBanks. It is highly unlikely that any FDIC trust fund money would be lost – let alone any taxpayer money be needed to back up the FDIC. So a crisis in iBanks would not induce a crisis in the real banks, although some of the more reckless banks might get new owners.

      • formula57 says:

        Yes, I see and I had hoped myself that that might be the answer but I am not clear that it is.

        If a regular bank was to experience a run (caused by its IB/shadow bank depositors themselves being in difficulty) then would not the Central Bank (CB) feel itself obliged to act in its Lender of Last Resort (LOLR) capacity (justified (i) because the regular bank is solvent, just illiquid and (ii) to prevent material disruption to the payments system)? Coppola herself makes the point that whilst the IB and shadow banks remain customers of the regular banks, such action by the CB is going to be considered necessary. The alternative, as you say, is a “reconstruction” in the terms you outline and I for one would welcome that but would that in fact represent great risk for the public good than a CB LOLR operation? Either way, I do share much of Coppola’s opinion that a new GS would change matters very much.

      • formula57 says:

        EDIT – last sentence – “would NOT change matters very much”.

      • DeDude says:

        All depending on the situation it is possible that the Central Bank in a crisis would set up a TALF (or what have you) where a bank could get cash for certain of its otherwise “firesale” assets. A traditional bank would actually hold mortgages and other real stuff (not speculative CDO, etc.). The Fed might tell real banks that they can borrow 70% of the value of any mortgage they deposit (even if a crisis firesale of that mortgage in a panic marked could only give them 50%). Then that bank may be able to survive and pay back the deposited cash to the iBank. But that is different from a backstop and bailout of the iBank, since the iBank would simply get back the money it had deposited in a solvent FDIC insured regular bank. If that cash (which was the iBanks legitimately owned cash) was not enough for the iBank to dig itself out of the hole it had gotten into, then it would fail without taking the real bank down. with it.

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