Glass-Steagall and Deregulation: What Went Wrong?

Nothing, really. Consortium members Warren Gibson and Jeffrey Rogers Hummel write in the Freeman on Glass-Steagall and what its repeal in the 1990’s meant for the economic crisis that began in 2008:

The timing of the repeal of Glass-Steagall makes this deregulatory move a convenient scapegoat for the financial crisis. But the crisis began with the housing collapse, a result of government encouragement of unsound lending practices. Financial firms took too much risk with mortgage-backed securities, in part because of moral hazard engendered by government guarantees and partly because bond rating firms were not as independent as was once thought. The limited liability that the investment banks gained when they became corporations may also have amplified moral hazard. There is no good reason to believe that Glass-Steagall, had it remained in effect, would have prevented any of these problems.

I highly recommend this piece. Lots of good history behind the law as well as a very clear explanation of the different types of banking services, what they do, and how they are created.

4 thoughts on “Glass-Steagall and Deregulation: What Went Wrong?

  1. Been reading from Peter Schiff. From chapter four of his book, The Real Crash,

    One of the problems when talking about the banking industry is that the government distortions are baked so deeply into the cake that many discussions of “deregulation” or “subsidy” get hopelessly confused. A good example of confused “deregulation” was the Gramm-Leach-Bliley Act of 1999, removing some barriers to what banks could do.

    It was heralded by conservatives at the time as free-market reform, and then blamed by liberals in 2008 as reckless deregulation. But both critics and defenders tried to explain Gramm-Leach-Bliley outside of its context.

    Here’s the context:

    The 1933 law that created the FDIC was sponsored by Senators Carter Glass and Henry Steagall. It was known as the “Banking Act.” The bill was also known by its sponsors’ names. In addition to creating the FDIC, Glass-Steagall also prohibited bank holding companies from owning other sorts of financial institutions. Basically, commercial banks couldn’t also be investment banks.

    In the event of the financial crisis of 2008, when liberals were blaming “deregulation” for our problems, most of the blame was placed on “the repeal of Glass-Steagall.” This was a reference to Gramm-Leach-Bliley, signed by President Clinton in 1999.

    But Gramm-Leach-Bliley did not “repeal Glass-Steagall.” If it had, it would have abolished the implicit bailout provided by the FDIC. But instead, it just removed the regulation that had tried to contain some of the moral hazard created by the FDIC.

    In other words, the market used to regulate the banks. Glass-Steagall killed the market regulation and replaced it with government regulation. Gramm-Leach-Bliley killed the government regulation, but didn’t replace it with anything.

    Had I been in Congress when Gramm-Leach-Bliley was debated, I would have proposed an amendment abolishing the FDIC and the rest of Glass-Steagall. Had my amendment failed, I would have voted against the bill.

    The way I see it, as long as the federal government is cosigning all of the bank’s debt, the government has the right to give some marching orders to the bank. If I asked you to cosign my loans, you might place some conditions on me, such as, no taking this money and going to Vegas. In theory, government shouldn’t be telling anyone what to do with their money, but once government becomes the insurer, it gains that right.

    So if you don’t want government telling banks what to do, get the banks off the government dole.

  2. The removal of Glass Steagall served to create banks that were, during the housing market collapse, “too big to fail” because it allowed investment houses to gobble up banks instead of the two remaining separate monetary commercial vehicles that were less concentrated in wealth and marginally checked decision making and competitive practices.

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