GLASS-STEAGALL | Three Myths

Glass-Steagall kept speculative foxes out of the commercial-bank henhouse.

Myth #1: Glass-Steagall is too complex for ordinary voters to understand. An investment banker says: "If one percent of people actually know what Glass-Steagall did and what it would do now, it’s not more than that.”  He says the Glass-Steagall issue will not change anyone's vote.

Fact: The law was simple – that's why it worked fine for half a century.  It traded federal deposit insurance for risk-limiting bank regs. People know the 2007-2009 crisis came from deregulation.

The Glass-Steagall Act (i.e., the Banking Act) of 1933 had two main parts. House Banking Chairman Rep. Henry Steagall, Democrat of Alabama, was carrying water for the banks, which wanted deposit insurance. They got deposit insurance up to $2,500 (soon raised to $5,000) per account.

Not complicated is that the half of the Banking Act of 1933 that the banks liked – deposit insurance – is still with us. The limit to coverage of deposit insurance has steadily increased 100-fold, from the original $2,500 per depositor to $250,000 per deposit account. Depositors are allowed to have more than one covered account (sole, joint, custodian etc.). Beyond that, the FDIC for valid efficiency reasons avoids the costly litigation involved in liquidating a bank and instead negotiates takeover over its assets and liabilities by a solvent bank. This in effect means 100 percent coverage of deposits.

FDR and Treasury Secretary Woodin were initially opposed to this giveaway to the banks. They were only induced to support Federal assumption of banking risks in return for bank regulations imposed in Sen. Carter Glass's bill, which was designed to protect the Federal Reserve System he helped create in 1913. 

Myth #2: Glass-Steagall was eliminated in 1999.
Fact: Only half of Glass-Steagall was gutted, the Glass part.

The Glass-Steagall law was simple. What was complicated was the piecemeal and devious dismantling by its opponents of the Glass component of the law, in the name of "modernization".  

The deregulatory moves culminating in the 1999 Gramm-Leach-Bliley Act kept the Federal deposit insurance and took down the wall between insured banking and speculative issuance of securities.

Harvard B School Prof. David A. Moss in 2009 put it well: [T]he success of New Deal financial regulation [may have] actually contributed to its own undoing. After nearly 50 years of relative financial calm, academics and policymakers alike may have begun to take that stability for granted. Given this mindset, financial regulation looked like an unnecessary burden. It was as if, after sharply reducing deadly epidemics through public-health measures, policymakers concluded that these measures weren’t really necessary, since major epidemics were not much of a threat anymore. [My italics.]

Former Federal Reserve Chairman Alan Greenspan said in October 2008: “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief.” Nothing too complicated about this story. 

Myth #3: Glass-Steagall was about the big banks. Hillary Clinton: "[In my proposed bill] I go after all of Wall Street, not just the big banks"
Fact: Glass-Steagall was not just about the big banks. It was about all FDIC-insured banks. It was about protecting the henhouse assets of all insured banks from foxes selling speculative securities.

Glass-Steagall was about putting a wall between the humdrum business of taking deposits from consumers and making loans back to them (the henhouse), and the risky business of speculating in business equity and debt (the foxes, or wolves).

John Reed, former Chairman of Citigroup, wrote last week in the Financial Times that he has come to the view that the wall between banks and investment banks was a good one.
"As is now clear, traditional banking attracts one kind of talent, which is entirely different from the kinds drawn towards investment banking and trading. Traditional bankers tend to be extroverts, sociable people who are focused on longer term relationships. They are, in many important respects, risk averse. Investment bankers and their traders are more short termist. They are comfortable with, and many even seek out, risk and are more focused on immediate reward. In addition, investment banking organisations tend to organise and focus on products rather than customers. This creates fundamental differences in values."