04.01.10

Glass-Steagall Re-revisited

Posted in Blog at 1:28 pm

An article in the Wall Street Journal on March 31, 2010 cited a senior regulator at the Bank of England on the very high social costs imposed by every banking bailout, and supported the notion that banks should not be allowed to grow “too big to fail,” because of the vast total cost of a banking crisis.  One reader replied that our former Glass-Steagall Act had put American banks at a disadvantage with respect to their foreign counterparts, and stated that “the move to repeal Glass-Steagall began fifty years ago.”  I can seldom resist the opportunity to reply to an historical misconception, and I wanted to clarify the record on U.S. banking deregulation.

The move to repeal Glass-Steagall began the day after it was passed. There are some who can’t stand any sort of regulation, and some who resent not being able to place the whole world under their own flag or logo.  The fact that both U.S. commercial banks and U.S. investment banks remained very profitable despite these restrictions was irrelevant.

The big European banks were the envy of the U.S. money center banks in the 1970s because of their broader deposit base, and especially because some savers, e.g., the Germans, were so risk-averse they were happy to leave billions in low-interest bearing deposits just to avoid the terrifying market risk posed by—bonds, for example. The fact that U.S. savers were unwilling to live with such low returns was disregarded.  The dreaded code-word of the day was ‘disintermediation’ [of the banking system] and we were supposed to avoid it by allowing state-wide and then interstate banking. If we’d had it sooner, it would have permitted our money-center banks to buy more market share in sovereign loans to Paraguay, for example.

After the survivors recovered from that one, and the geographical limitations upon our banks began to be erased, they turned their envy upon the universal banking franchise of the foreign banks.  Calls for the abolition of Glass-Steagall became louder.  Having the same freedom as the foreign banks would let them wheel and deal like the J.P. Morgans and National City Banks of the ‘twenties. Except that the foreign banks were mostly risk-averse, and avoided the kind of aggressive dealmaking that characterized our investment banks. They also maintained huge inner reserves that made their results less exciting, but made the banks safer. (Funny:  I never heard an American banker lobby for that particular freedom!)

Still, our libertarian regulators broke down the Glass-Steagall barriers so that our banks, with bigger equity bases than the Europeans and Asians, could buy up the investment banking world, and even corrupt some of their foreign counterparts. With the results we’ve seen, which were pretty much those feared by the architects of Glass-Steagall.  The commercial banks wanted the much higher return on assets of the investment banks, and the investment banks wanted to leverage up a larger capital base.  The investment banks did not want to submit to the regulatory burden of the commercial banks, and the commercial banks did not want to suffer the extreme volatility of return of the investment banks.  In the end, we got the leverage and the volatility—much more volatility than anyone had expected.  Anyone want to break down any more regulatory barriers?

Through most of the history of this saga of burdensome regulation and artificial barriers, the American banks remained some of the most highly-rated and most profitable in the world, with higher returns on assets and larger market capitalizations than most of their foreign counterparts. One question still troubles me:  What were they all whining about, and why should we have broken our system in order to accommodate them?

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