Bring back Glass-Steagall banking regulation

by Chana Cox

In Tuesday night’s Dartmouth debate, the Republican candidates were generally agreed on the need to repeal Dodd-Frank.  That is all well and good, but banking does need regulation.  For 70 years a cluster of New Deal laws, the Glass-Steagall laws, successfully prevented American banks from becoming “too big to fail.”  Dodd-Frank should be repealed, and an updated Glass-Steagall should replace it.

In 1933, the Glass-Steagall Act introduced the FDIC which insured bank depositors for up to $10,000 in loss because such insurance was seen to be essential to the maintenance of the banking system.  Once the taxpayers were on the hook for bank losses, Glass-Steagall severely restricted the risk to those taxpayers by restricting the scope of banks. The act separated commercial banking, the relatively low risk business of taking deposits and lending money from investment banking, the very high risk business of issuing securities and taking capital positions in businesses and in all manner of other investments.  Commercial banks were insured by the federal government, but they were to be stiffly regulated and limited in geographic scope.  No American bank would be allowed to do business in more than three states.

In contrast, investments banks were not restricted geographically and they were less regulated but they could not take deposits and their operations were not guaranteed or insured by the Federal Government.  Taken together, these Depression-era statutes limited tax payer exposure and risk and limited the size of any one commercial bank.  High risk investment banking could and did continue, but it was not federally insured.  Furthermore investment banks were often formed as partnerships and the individual partners were personally liable for the firm’s debts.

The 1999 repeal of Glass-Steagall was a disastrous game changer.  Commercial banks were allowed and even encouraged to engage in high risk activities – particularly those supported by the politicians in power.  The politicians used banks to advance their specific agendas, and the banks used the politicians to insure them against failure. At the same time, as the commercial banks became larger and larger, they became less and less effective as traditional lending institutions.  In Oregon, we were better served by First Interstate than we are now being served by its successor Wells Fargo; we were better served by Washington Mutual than we are now being served by Chase; and Bank of America was a strong West Coast bank but it has become a very weak national bank.

After 1999 these newer, larger, freer commercial banks were finding it very profitable to take increasingly risky positions in other markets, like mortgage-backed securities and credit default positions.  Under Glass-Steagall such investments would have been illegal for a commercial bank.  Instead, commercial banks would have been lending money to local citizens and businesses.  They would have been serving their communities as bankers.  These riskier investments should be illegal for banks not because they are risky but because it is the taxpayers who are at risk.  Our bankers are playing roulette with taxpayer money.  If individual bankers win, they are rewarded with multi-million dollar bonuses that get paid out every year; if they lose, the taxpayers foot the bill.  Mere months before the repeal of Glass-Steagall, Goldman Sacks, the quintessential investment bank, went public as a corporation and ceased to be a partnership.  The partners were no longer liable for the debt – the corporation was.  No one was personally liable.  Goldman Sacks has now taken the further step and legally turned itself into a bank.  Now, even the corporation is not liable – the Federal government and its taxpayers are Goldman Sacks debt.  That has proven very expensive for the taxpayers.

In the 1990’s one argument offered for the repeal of Glass-Steagall was that America’s banking system, with its restricted local banks, was inferior to the far more powerful and monopolistic European banks.   The banking industry preferred the European model.   Ten years ago Deutsche Bank, through its own share position, was in control of much of the German economy.  The European banks were far more powerful than the American banks and American bankers wanted that kind of power.  In retrospect, we have come to understand that the major European banks have contributed greatly to the current European financial breakdown.

The Glass-Steagall laws successfully regulated the American banking systems.  In crisis situations, like the savings and loan crises of the 1980s, the government could step in and save depositors.  The problems were manageable.  Once banks were allowed to go national and to go into virtually any and all investments, the problems became unmanageable and the moral hazard for both the bankers and co-dependent politicians became catastrophic.  Banks were too big to fail and too unregulated to save.  Dodd-Frank merely exacerbates those problems.

Bring back Glass-Steagall.

 

Chana Cox is a Senior Lecturer Emerita at Lewis and Clark College, and she has a Ph.D. from Columbia University and a BA from Reed College. She has been a featured speaker at U-Choose events.

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Posted by at 05:00 | Posted in 2012 Presidential Election, Economy | 34 Comments |Email This Post Email This Post |Print This Post Print This Post

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