GLASS-STEAGALL | Bipartisan Support (Updated March 12, 2017)

Sen. Carter Glass, Feb. 1933

July 27, 2016—Andrew Ross Sorkin (New York Times, July 26, p. B1) considers it "an extremely odd political dovetail" that both Democratic and Republican platforms include planks calling for the restoration of the 1933 Banking Act, widely referred to as Glass-Steagall.

The GOP platform is not consistent. It has some anti-regulatory provisions diametrically opposed to a restored Glass-Steagall Act. But a coalition between Republicans and Democrats on major financial issues is not odd at all:

• The coalition that brought down the Philadelphia-based Hamiltonian Second Bank of the United States united Old Republicans opposed to growing Federal power and Jacksonian Democrats opposed to the reining-in of bank lending.
• The coalition that created the Federal Reserve in 1913 included Republican Senator Nelson Aldrich and several Wall Street bankers, who drafted a privately controlled plan at a "duck hunt" in November 1910, and Democratic Congressman Carter Glass of Virginia, who with President Woodrow Wilson added provisions for greater public control.
  
• FDR's Republican Treasury Secretary, the unjustly forgotten Will Woodin, calmed the financial markets in 1933 and got both houses of Congress to agree in a single day to an Emergency Banking Act and then to the 1933 Glass-Steagall Act.

When I was working as a financial economist at the Federal Reserve Board in 1964-66, Bray Hammond's history of banking was still fresh in the minds of researchers there. Hammond had been Assistant Secretary to the Board of Governors of the Federal Reserve System through 1950. He  wrote Banking from the Revolution to the Civil War (key chapter posted here) that won a Pulitzer for history in 1958.

Today's Main Street coalition has coalesced in reaction to the 2008 meltdown. It is broad and deep but it is the same coming-together that has stood the United States well since the Revolution.

Glass-Steagall was named after Sen. Glass, now chairman of the Senate Banking Committee, and Rep. Henry Steagall of Alabama, chairman of the House counterpart committee. Working under pressure from FDR and Woodin, Glass and Steagall fashioned a law that was a powerful bargain. The banks originally got deposit insurance up to $2,500 per account holder from Steagall in return for strict regulations designed by Glass to separate insured from non-insured financial institutions.

Woodin and FDR were both fully aware of the hazard that investment bankers would try to get access to insured deposits to speculate with, which is why they deeply opposed deposit insurance unless accompanied by strong regulation of banks covered by such government-backed insurance.

Deposit insurance coverage was ultimately expanded. Depositors were allowed to have different insured accounts at the same bank (retirement, joint, etc.). Coverage was raised in steps to $40,000 and, in 1980–in a move that the FDIC itself opposed–to $100,000. The increase to $250,000 was in response to the 2008 meltdown and arguably encouraged the same disregard of risk that caused the meltdown. In practice, when a small bank gets into trouble the FDIC arranges a takeover. If the bank is too big the fail or be taken over, the 2008 Lehman takeaway is that the Fed is likely to finance the bank's losses to preserve the financial system.

Meanwhile, while the regulations installed by Carter Glass lasted more than half a century. Their erosion in steps through 1999 in the name of "modernization" paved the way for the 2008 crisis.

UBS MESS | 4 Reasons Glass-Steagall Rocks

Sept. 16, 2011—I'm reading about the arrest in London of Kweku Adoboli of the Swiss investment bank UBS at the Randolph Hotel in Oxford, overlooking Balliol College. Alice and I are here for the Oxford University Reunion Weekend—it's 49 years since I  matriculated.

Mr. Adoboli, the young UBS trader, made a $2 billion mistake, it seems. Using his Delta One trading system, he bought Swiss francs as a hedge when he meant to sell them. Before he realized his mistake, if we can believe this, the market ran away with his bet. Swiss francs fell in value. UBS took the hit for a couple billion. This exceeds Nick Leeson's $1.3 billion loss, which brought down Barings in 1995. It ranks third after Jerome Kerviel's $6 billion loss at Société Générale in 2008 and Yasuo Hamanaka's $2.6 billion loss at Sumitomo in 1996. All this from today's Independent, delivered to my door this morning.

For UBS, the timing is bad. It had just started to show a profit in 2010. So long as no one bails out UBS, the victims are (and should be, based on the published information so far) UBS employees and shareholders.

But for the just-issued Vickers Report, from Britain's Independent Commission on Banking chaired by Sir John Vickers, the timing couldn't have been better. It shows how risky the "casino" banks are, and how frail is their ability to control it.

The Vickers Report recommends reversing some of Britain's "Big Bang" deregulation of 1986 by "ringfencing" retail (commercial) banks with a separate board of directors and shareholder equity that is at least 10 percent of risk-weighted assets. The plan is for new controls to be in place by 2019.

A key element of the Vickers recommendations is that commercial banking and investment banking be separated. This was a central component of the Glass-Steagall Act of 1933, separating commercial banking from investment ("casino") banking.

An opponent of the Vickers recommendations, Martin Jacomb, protested against them in the September 14  Financial Times (p. 15), the day after the Vickers report was publicized:

Commentators speak loosely about going back to Glass-Steagall. But the Glass-Steagall Act was introduced to deal with a problem that no longer exists: the distribution of fraudulent securities to uninformed customers. It was abolished because customers wanted the services universal banks can provide.

Sorry, but that loose statement is just wrong. Let me count the ways:

1. Glass-Steagall was not abolished. The Steagall part, having to do with deposit insurance and insured-bank regulation, is still very much in force. What was eaten away over time was the fence around the banks and the FDIC's ability to contain the problem.


2. Distribution of fraudulent securities to uninformed customers is still a problem. Does anyone believe that the underfunded securities regulators will prevent any future Bernie Madoff from emerging, or any future misdescribed and toxic derivative?


3. Glass-Steagall was designed to prevent runs on banks. The three-part program of the Banking (Glass-Steagall) Act of 1933 was to keep the foxes of speculative banking (the "casino" bankers) out of the chicken-coop of commercial banking, to empower the Federal Depsoit Insurance Corporation to insure deposits, and to regulate insured banks on behalf of depositors and the federal insurance fund. It also keep insurance companies out and also created the Federal Open Market Committee, which still sets U.S. monetary policy. It has worked well, and for 75 years the FDIC took care of ailing commercial banks without massive external funding.


4. "Customers" did not demand the erosion of Glass-Steagall.  The legislative record of U.S. bank deregulation and subsequent actions of investment banks shows the ending of many Glass-Steagall protections  was driven by financial speculators seeking  access to the deep pockets of commercial banks and (via credit default swaps) insurance companies. There was no customer-driven yearning for "universal banking".

As the Economist said in 1999, the erosion of Glass-Steagall protections should have been accompanied by new regulations for investment banks. The United States Government unwittingly became a guarantor of  "casino" bankers - and insurance companies - without the limitations that came in 1933 with deposit insurance. The  failure of Lehman Brothers three years ago showed how perilously far into the commercial banking business investment banks had penetrated. The latest UBS fiasco shows the urgency of preventing a repeat of that situation, starting with implementation of Dodd-Frank.