I am afraid that the reinstatement of the Glass-Steagall Act will not be sufficient (or even helpful) to preventing further problems in the financial sector.

The essential purpose of the Glass-Steagall Act was to separate commercial banking from investment banking. This was a problem in the 1920s because many retail banks helped companies to issue shares and bonds (i.e. investment banking) by selling these to their own commercial banking customers, as well as speculating with their money as well. This meant they were able to make huge profits by basically selling sub-standard securities to themselves, and led to the almost-collapse of the commercial banking system.

That AIG was allowed to build up what was basically a hedge fund whose losses led to the near-bankruptcy of the group is a clear problem (as Bernanke pointed out), but Glass-Steagall would not have prevented this. Similar, many commercial banks like Citi and Wachovia would have been able to make all the bad subprime mortgage lending decisions anyway, whether or not they were doing investment banking. (Countrywide and WaMu are examples of pure-play commerical banks / lenders which got into trouble.)

So, unfortunately, while we do need stronger and more comprehensive regulation of the banking sector, brining the Glass-Steagall Act back is no really going to help.

posted March 18, 2009

different legislation. bank modernization act repealed glass-steagall, commodity futures modernization act kept futures unregulated.

25 People to Blame for the Financial Crisis; Phil Gramm
http://www.time.com/time/specials/packages/article/0,28804,1877351_1877350_1877330,00.html

from above:

He played a leading role in writing and pushing through Congress the 1999 repeal of the Depression-era Glass-Steagall Act, which separated commercial banks from Wall Street. He also inserted a key provision into the 2000 Commodity Futures Modernization Act that exempted over-the-counter derivatives like credit-default swaps from regulation by the Commodity Futures Trading Commission. Credit-default swaps took down AIG, which has cost the U.S. $150 billion thus far.

... snip ..

Gramm and the 'Enron Loophole'
http://www.nytimes.com/2008/11/17/business/17grammside.html

from above:

Enron was a major contributor to Mr. Gramm's political campaigns, and Mr. Gramm's wife, Wendy, served on the Enron board, which she joined after stepping down as chairwoman of the Commodity Futures Trading Commission.

... snip ...

Phil Gramm's Enron Favor
http://www.villagevoice.com/2002-01-15/news/phil-gramm-s-enron-favor/

from above:

A few days after she got the ball rolling on the exemption, Wendy Gramm resigned from the commission. Enron soon appointed her to its board of directors, where she served on the audit committee, which oversees the inner financial workings of the corporation. For this, the company paid her between $915,000 and $1.85 million in stocks and dividends, as much as $50,000 in annual salary, and $176,000 in attendance fees, according to a report by Public Citizen, a group that has relentlessly tracked Enron, which in turn has called the report unfair.

... snip ...

Greenspan Slept as Off-Books Debt Escaped Scrutiny
http://www.bloomberg.com/apps/news?pid=20601109&refer=home&sid=aYJZOB_gZi0I

from above:

That same year Greenspan, Treasury Secretary Robert Rubin and SEC Chairman Arthur Levitt opposed an attempt by Brooksley Born, head of the Commodity Futures Trading Commission, to study regulating over-the-counter derivatives. In 2000, Congress passed a law keeping them unregulated.

... snip ...

one of the articles from the period mentioned that House passed the bill ... and even before the copy of the bill was distributed in the Senate, the Senate passed it unanimously. Also Born (as chairman) must have been fairly quickly replaced by Gramm's wife (before she resigned the position to join Enron).

Enron, Worldcom, deregulation, & repeal of Glass-Steagall also investigated by PBS:
http://www.pbs.org/wgbh/pages/frontline/shows/wallstreet/

Sarbanes-Oxley was passed in the wake of ENRON ... but the underlying problem wasn't address. SOX put most of the responsibility on SEC ... which doesn't seem to have been doing a lot. In the Madoff hearings, the person that had been trying to get SEC to do something about Madoff for a decade wasn't very complimentary. They also mentioned that there are some number of other similar ponzi schemes out there. The repeated refrain that crooks and fraud thrive where there is lack of transparency and visability.

Possibly because GAO didn't think SEC was doing much ... they started a database of public financial filings with problems (there was some reference that problems had increased over 300% in period after SOX vis-a-vis the 90s)
http://www.gao.gov/special.pubs/gao-06-1079sp/index.html

from above:

The database consists of two files: (1) a file that lists 1,390 restatement announcements that we identified as having been made because of financial reporting fraud and/or accounting errors between July 1, 2002, and September 30, 2005, and (2) a file that lists 396 restatement announcements that we identified as having been made because of financial reporting fraud and/or accounting errors between October 1, 2005, and June 30, 2006.

... snip ...

posted March 18, 2009

I am all for laissez-faire, however, I believe Glass Steagle Act of 1933 (with regard to the separation of financial institutions) should be reinstated. It would not have stopped the melt down of investment banks; however, AIG would have been only in the insurance business and not in the investment business under the Act. Therefore, they would have substantially less problems than they have now.
The corruption in the securities business has not changed in all the thirty plus years since I have been associated with it, however, no one but a fool was not aware of that (and many politicians). Combine that with the conflicts of interest that abound in institutions that sell insurance, securities and banking services. If AIG had only sold insurance, they probably would have become “too big to fail.”
But before I get attacked for that last statement, let me say, under normal circumstances I would agree that we should let insolvent institutions file for bankruptcy. However, AIG IS too big to fail. While bankruptcy might have been better for the company, it would have hurt millions of people and institutions.
When AIG first started having problems, many people inquired whether there life insurance and annuity policies were safe. They were assured that their policies were fine because they were also covered by state guarantee funds. However, if AIG failed, many of those state guarantee funds could have been bankrupted. That is how large AIG is and that is why I believe it is n this county’s interest to not let it fail.

posted March 18, 2009

Hi Michael:

I do not see any advantage in resurrecting a legislation designed for a financial architecture of 1933 even though it was upheld until 1999. What I think we need is a new financial architecture that would patch loopholes that can potential damage the economy in the same way that it did now. We should have financial products that are transparent, and do not pose excessive risks. In addition to that, I have heard many people recommending a new financial product approval process the same way we approve tangible products such as toys, medicines .etc. That could play a very important role in a risk-based approach by the government agencies and can prevent potential damaging financial instruments from entering the market. Now, did the repeal of that act contributed tot he financial crisis; absolutely, could it had prevented the crisis; to a small extent yes, but there are other areas that the above act does not cover thus the financial crisis might have been inevitable with or without the act.

Please feel free to contact me if you wish to discuss this further.

Petros

Links:

• http://en.wikipedia.org/wiki/Glass-Steagall_Act

posted March 22, 2009

In my opinion, it was correct to repeal it. The industry should not have been fettered in that way.

The problem has been that regulators, boards of directors, external auditors, and rating agencies, all utterly failed to do their job, abdicating their responsibility.

posted March 18, 2009

Yes.

posted March 18, 2009

Yes it should be re-introduced. The problem of not having that separation of banking and insurance is that the attraction of the wide open risk market that this created caused banks to earn all of their 'profits' from risk based products and no longer to focus on their fiduciary duty of care towards protecting client deposits. This led to massive overleveraging of balance sheets. Michael Lewis's The End puts it very well.

posted March 18, 2009

In my opinion it should never have been repealed. All of these problems in banking are due to controls being removed on banks participating in the market.

If Glass-Steagal were in place, then the banks couldn't have held large positions in mortgage-backed securities which is part of the reason for this mess. Fannie and Freddy are the other major culprit. All thanks to our Congress that perpetuates idiocy at the taxpayer expense.

posted March 19, 2009

The following arguments for preservation of GS and against from 1985 appear in Wikipedia:

The argument for preserving Glass-Steagall (as written in 1987):

1. Conflicts of interest characterize the granting of credit – lending – and the use of credit – investing – by the same entity, which led to abuses that originally produced the Act

2. Depository institutions possess enormous financial power, by virtue of their control of other people’s money; its extent must be limited to ensure soundness and competition in the market for funds, whether loans or investments.

3. Securities activities can be risky, leading to enormous losses. Such losses could threaten the integrity of deposits. In turn, the Government insures deposits and could be required to pay large sums if depository institutions were to collapse as the result of securities losses.

4. Depository institutions are supposed to be managed to limit risk. Their managers thus may not be conditioned to operate prudently in more speculative securities businesses. An example is the crash of real estate investment trusts sponsored by bank holding companies (in the 1970s and 1980s).

The argument against preserving the Act (as written in 1987):

1. Depository institutions will now operate in “deregulated” financial markets in which distinctions between loans, securities, and deposits are not well drawn. They are losing market shares to securities firms that are not so strictly regulated, and to foreign financial institutions operating without much restriction from the Act.

2. Conflicts of interest can be prevented by enforcing legislation against them, and by separating the lending and credit functions through forming distinctly separate subsidiaries of financial firms.

3. The securities activities that depository institutions are seeking are both low-risk by their very nature, and would reduce the total risk of organizations offering them – by diversification.

4. In much of the rest of the world, depository institutions operate simultaneously and successfully in both banking and securities markets. Lessons learned from their experience can be applied to our national financial structure and regulation.[7]

It's obvious from what occurred that some form of regulation with respect to assumption of risks with catastrophic dependencies is necessary and the key to the efficacy of any regulation is the ability to monitor effectively and enforce it.

Consider what happened in the Madoff case. Someone was blowing the whistle for years but the SEC ignored him and the people that were supposed to be doing the oversight were incompetent. Getting the oversight function correct and staffed with people with the appropriate expertise is essential.

posted March 19, 2009