Yves here. Aside from the foursquare case that Professor Black makes for reinstituting Glass-Steagall, another important set of arguments came in 2009 from Andrew Haldane, director of financial stability at the Bank of England. Haldane pointed out that diversity in the financial system had plunged in the runup to the crisis, with major banks in the same businesses and pursuing largely parallel business strategies. In biology, limited diversity results in a lack of robustness. Ecosystems with one or a few dominant species are more vulnerable to collapse than ones with more variety. So the reintroduction of Glass-Steagall would force more diversity (retail versus investment banks) on a still dangerously homogenous population.
By Bill Black, the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. Cross posed from New Economic Perspectives
Glass-Steagall prevented a classic conflict of interest that we know frequently arises in the real world. Commercial banks are subsidized through federal deposit insurance. Most economists support providing deposit insurance to commercial banks for relatively smaller depositors. I am not aware of any economists who support federal “deposit” insurance for the customers of investment banks or the creditors of non-financial businesses.
It violates core principles of conservatism and libertarianism to extend the federal subsidy provided to commercial banks via deposit insurance to allow that subsidy to extend to non-banking operations. Absent Glass-Steagall, banks could purchase anything from an aluminum company to a fast food franchise and (indirectly) fund its acquisitions and operations with federally-subsidized deposits. If you run an independent aluminum company or fast food franchise do you want to have to compete with a federally-subsidized rival?
Deposit insurance is a material federal subsidy, but it pales in comparison to the implicit federal subsidy we provide to systemically dangerous institutions (SDIs) (so-called “too big to fail” banks). The SDIs are precisely the banks most likely to purchase non-commercial banks. The general creditors of SDIs are protected against all loss so they funds to SDIs at a substantially lower interest rate than smaller competitors. The largest SDIs are commercial banks that get both the explicit subsidy of federal deposit insurance and the larger subsidy unique to SDIs.
No conservative or libertarian should want the SDIs to maintain their political and economic dominance. The SDIs’ dominance comes about not due to their efficiency but their size and the size of their lobbying wallet and force that allows them to extort greater federal subsidies than their rivals. If conservatives and libertarians have any uncertainty about their position on Glass-Steagall they should consider these facts: (1) President Obama opposes ending the SDIs, (2) has done nothing effective to end the large federal subsidy provided to the SDIs, and (3) opposes bringing back Glass-Steagall and removing the explicit federal subsidy to banks that indirectly provides a competitive advantage to their commercial affiliates.
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The whole point of repealing Great Depression era banking legislation in the first place was to return the commercial banks to profitability. When Continental Illinois failed, it heralded an end to the era of commercial banks. Reviving Glass-Steagall seems like a half measure at this point. It would be akin to slapping a band-aid on to a gunshot wound to the head.
Huh? I don’t know where you got that idea from, but it’s just not correct.
Glass Steagall was one of those weird bits of legislation that was more salutary than it had any right to be.
The Jewish investment banks and the Rockefeller interests (Chase Bank) teamed up to break the House of Morgan. The ONLY consequence at the time of the passage of Glass Steagall was to force the division of the House of Morgan into the JP Morgan bank and Morgan Stanley. Tom Ferguson has written this up and can even point to the funding blocks behind this strategy (he’s also done archival research and there’s ample supporting documentation).
And I see no connection between the failure of Continental Illinois, which was a classic case of a bank growing too fast and levering up a bit too much and taking on too many loans and investors applauding and regulators asleep at the switch (http://www.fdic.gov/bank/historical/history/235_258.pdf), and the erosion of Glass Steagall.
I was very much on top of this at the time, since my job at McKinsey was to help commercial banks in their efforts to get into investment banking in the few places they were allowed to play. Citi was far and away the most aggressive in pushing for new regs and up-skilling in the markets where regulations were looser. But all the commercial banks were salivating to get into investment banking simply because the ROE in those busineses were more than double those of commercial banking. This was all management push. No way did it have squat to do with regulator concerns.
Not really the point I was trying to make on the Glass-Steagall bit, so I’ll concede that point.
Our commercial banking sector merged and consolidated quickly starting during the late 1970s due to their falling profitability. The depression-era restrictions against investment activity were also loosened. What followed next was the increase in their leverage. Between the increased concentration and market share Continental Illinois was deemed Too big to fail when it faltered.
But it really didn’t function as a commercial bank anymore. Correct me if I’m wrong but wasn’t the failure of Continental Illinois due to the fall of commodity prices they had leveraged up and bet on? I could’ve sworn they had their hands deep into oil leases, development of fields, metals, etc.
With the recent discovery that Goldman and JPMorgan are deep into commodity speculation…. I have a bad feeling about this!
I should also add that our regulators enabled this situation every step of the way. So there’s no telling if they’re still asleep at the wheel.
Re Continental, the FDIC link gives a good post mortem. They were already wobbly due to having made a lot of straight up but sorta risky C&I loans and having sovereign debt exposure. What knocked them over was that they were also an upstream banks to Penn Square (oil loans, not leases).
Re investment bank v. commercial bank deregulation, I have to say you just aren’t right here. The big impetus until the early 1990s was from the industry pushing Congress and regulators, not the other direction. In the 1970s, the big driver was interest rate increases and volatility. That led to deregulation of interest rates, and as money market funds kept eating bank lunches, product “innovation” like the negotiated order of withdrawal account (note that Paul Volcker then and now hated MMFs and if he had had anything to do with it they would have had a lot more curbs on them).
Credit cards that were marketed across state lines, which undermined state usury ceilings, were the result of a Supreme Court decision, not deregulation. I’m fuzzy on the timing of the key decisions, since branch banking was never my beat, but the rise of interstate banking was a late 1970s-early 1980s phenomenon.
Citi was really pushing hard, and they didn’t get many breaks. The big one came when banks were allowed to set up subs that did more securities dealing (up to a certain % of revenues). Even in the mid 1990s, the major banks were not contenders in the more lucrative equity business. JP Morgan had spent a lot of time and money becoming leader in the commoditized parts of the debt business by the early 1990s: a lot of effort but not a lot to show for it, profit-wise.
What changed the profit dynamics for the banks wasn’t underwriting but derivatives. They had an advantage by virtue of being in the FX business (FX derivatives were a good product) and interest rates (Treasury trading and interest rate swaps, which Citi had created in the 1970s). That was the high-margin, high value added product that enabled them to start taking ground and having high enough profits that they started looking like a decent platform. You also needed a really big balance sheet to do derivatives, so that played to the banks’ advantage. It was also in this period (1993-1999) when the serious erosion of Glass Steagall prior to its dismantlement took place.
Thanks for the write-up Yves. It’s provided a degree of clarity, especially where I’ve very clearly exceeded my level of competence.
I’ve assumed that when commercial banks lost a major source of their profits through the corporate issue of commercial paper, this factor drove the commercial banking sectors consolidation. While regulators reluctantly allowed them to diversify into more investment orientated business. Considering that regulatory institutions had more teeth back then, (and a willingness to use them) this wasn’t too big of a deal. Since this period preceded the financial innovation that gave Volcker fits. It’s in this context that I’m worried about the profit viability of commercial banks that don’t run the speculative risks that caused Continental Illinois to fail.
I think ‘Age of Greed’ – Jeff Madrick also has a good treatment of this issue.
Indirectly you could also say that some greedy shysters like Walter Wriston and others like him in his wake did the worst damage to banking regulation in this country. Bringing back Glass-Steagall, breaking the TBTF banks up and soldering shut the lips that sow confusion about commercial banking and investment banking and derivative this and blah that is the solution we need today. What we have learnt since the 1970s is we had good water tight regulation in Glass-Steagall. It was short public memory that was the weak link. “What has been will be again, What has been done will be done again, there is nothing new under the Sun” – Eccelesiastes 1:9
The Wealthy Fat Cat waits for Society to forget and for politicians to smell it in the air, pols like Jim Wright, Tom Foley and Clinton for instance. To aid these Judases in their corruption the Think Tanks do the heavy lifting of moving public opinion.
The answer always – always has been progressive taxation.
One could go out on a limb and even say that we do not even need to redistribute – just merely taking the money out of greedy hands is good enough to reinstitute equity in Society. All the proof we need for 90% marginal tax rates are the number of private Right Wing and Libtard Think Tanks that have been set up since the 1970s or even earlier from the last Gilded Age and see how they have worked to befuddle and cloud public opinion in a thousand insidious ways – all in the service of more private profit and to route money from the pockets of the middle class and the Government coffers straight into their bank accounts.
‘Private Enterprise’ today is a fig leaf for the GOP and the Libtards. They don’t give a rats ass for Private Enterprise – they mean Private Capital when they say ‘Private Enterprise’ and they care not a whit about what the ‘Enterprise’ is as long as it increases profits.
>> our regulators enabled this situation
Calling yes-men “regulators” is Orwellian.
The “regulators” you’re referring to are the yes-men ushered in on a wave of enthusiasm for laissez faire, working on behalf of politicians campaign-financed by plutocrats.
You seem to be calling these turncoats “regulators” to discredit the idea of regulation, policing.
“You seem to be calling these turncoats “regulators” to discredit the idea of regulation, policing.”
That’s ridiculous. Especially if you consider previous comments I’ve made regarding the re-birth of laissez-faire capitalism. I’m more concerned with where we are going to draw the line concerning a traditional commercial bank that is allowed certain investment opportunities. Where regulators will enforce such limitations of those opportunities, and so on.
Imagine the shitstorm that would instantly be created if Bill Black were to be nominated for any position where he might have an impact on the myriad criminal rackets that are laughably called financial markets. …. You’ll have to imagine it, ’cause it ain’t ever gonna happen with the mafia government that runs the US.
Bill Black manipulates his economic theory to meet his political theory. Exceptionally dangerous but if you agree with the political theory, it’s easy to accept the economic theory.
Steve — could you please flesh out your attack on Bill Black? I’ve read a large part of his writings and I am at a total loss on what you’re using as a base for your venomous attack.
No point in distinguishing between the labels. Goldman dba “conservatives” doesn’t want re-regulation, Goldman dba “libertarians” doesn’t want it, Goldman dba “progressives” doesn’t want it. They’re not ideologies, they’re just different LLC shells set up to handle different properties.
Bill Black is a god that walks the planet.
Prudent theft is still theft. And redlining existed long before Glass-Steagall was repealed. Was redlining prudent or did it lead to urban riots in the 1960s?
Is anyone “creditworthy” of his neighbor’s purchasing power even if he can successfully repay the bank?
We can do better as anyone who has ever looked at a balance sheet and noticed that Equity and Liabilities are on the same side and thus both can be issued as Asset-backed money.
append “should know.”, please.
Let us assume Glass Stegal gets reinstalled. This splits the retail banking from Investment banking. Still these Investment Banks on their own could bring the financial system down.
How do we ensure the following does not happen:
1. The Fed runs to rescue them
2. Congress creates another TARP (TARP or Else world ends stuff)
3. The Fed creates Alphabetical Bailut Acronyms all in the guise of supporting Main Street
4. The Fed screws Savers and Retirees
5. The Fed, FDIC and SEC sleep on the wheel
6. Leverage does not go to levels which can bring down the system
We seem to be talking about what would be in the interest of the Main Street whereas the Fed is all about ensuring Wall Street is intact (allowing them to recapitalise at the expense of Savers and Retirees)
I agree with those who maintain that retail banking is akin to a public utility. Without our payments system we literally cannot conduct business at any level. As it would be if we were out of electricity, commerce would just stop and we would risk chaos. Most believe that the TBTF banks were not allowed to fail because of Congress’ desire to protect the fat cats that support them. Maybe I am naive but I believe that many legislators detest the bankers actions as much as we do but when faced with the reality that our entire economy was threatened because our payments system failed was something that could not be risked regardless of the consequences. As a practical matter, the interconnectness of the TBTF banks’ operations and the global operations bringing into play the laws of many countries, their lawyers were in position to threaten to stop payments for all of us and bring commerce to a complete halt. Bank profitibality, global competiveness, diversity, etc. are all theoretical issues that have apparent relevance, but are beside the point. We cannot risk having our payments system held hostage while we debate those finer points any more than we can do without water or electricty. For this compelling reason alone, Glass Steagall must be reinstituted. Everything else said on the subject is just noise.
We cannot risk having our payments system held hostage while we debate those finer points any more than we can do without water or electricty. Whine Country
True. Which is why a risk-free fiat storage and transaction service (i.e. Postal Savings Service) should be established immediately and government deposit insurance (and the Fed) abolished. That service should be free up to normal household limits on account size and number of transactions.
This would separate depositors who merely wish to do business from those who also want to gamble.
An old solution Beard and I fully concur. On Whine’s worry re sky will fall, why are all Germans and Japanese not dead given the outcome of WW2? And we should worry about a few banks? Feather duster threat at 50 paces detected!
We have plenty of ‘researchers’ telling us government debt over 90% (whatever) screws GDP growth (somehow assumed a good thing) and precious little on resource and finance cursed countries and whether financial services is a massive opportunity cost (as in the UK) that drains investment and people from other sectors. All I’ve ever seen from this sector are products I would have rather had from a Post Office without the obscene fees earned with the equivalent of sticking my initials on a hot dog and charging me $100 dollars for it.
We’ve been had – they don’t really do anything other than steal behind the high street front. No need even for that with electronic money.
I support you and F Beard.
I wish to draw attention to some Swiss research done at the Federal Institute of Technology in Zurich – its on their site.
The conclusions were that interlocking Directorships own 40% of all public companies globally and they get 60% of the profits.
Glass-Steagle and other financial laws stemming from the Great Depression kept the economy stable for 50 years. As financial regulation began to be dismantled, we returned to the instability of the 19th century. Finally our latest financial crisis revealed the folly of deregulating finance. Engineers talk about mean time between failures. This time let’s aim for 100 years of stability before the next failure. Instead, what we have done is to bail out Big Finance and let the rest of the economy stagnate, with the risk of another downturn soon, while financiers talk about recurrent crises as though they were acts of nature.
I believe that in general a Libertarian would say that we should not have desposit insurance period. Which if you think about it is really not such a bad idea, since no deposit insurance would naturally work to decomplexify the financial system in an efficient manner, which would benefit almost everyone, despite some short-term (and necessary) pain.
despite some short-term (and necessary) pain. JGorden
Wrong. A temporary ban on new credit creation plus a universal bailout with new fiat*, at least until all deposits are 100% backed by reserves, would allow deposit insurance to abolished without causing bank failures.
Step away from the unimaginative, sadistic Austrians, I suggest.
*Metered to just replace existing credit as it is repaid to preclude price inflation.
Youre right, most Libertarians would agree with you on this.
But like on most economic matters… Libertarians have no clue what theyre talking about.
Er, no offence.
I doubt it would be short term pain. It would be long term and deflationary.
What “Libertards” want ideally is private control of all nations money supply which they essentially have now. How they then control it, is where they disagree.
Some would support a fractional reserve system with no government interventions. Other would want a global hard 100% backed standard. Considering the former is already in power essentially sans the central bank and the latter is out of power, that explains ALOT of the “talk” going on. A general idelogical civil war in the “libertarian” armies. Selgin vs. Schiff is a good start there in Jewish circles.
Goes back to FDR wimping out on the Chicago plan. Of course, he may have been fearful for his families life beyond other things, if FDR had backed the plan, there also may have been a coo.
I have never heard of such a plan being proposed, before you mentioned it. Thank you very much for mentioning it, looking it up has been quite insightful.
Heh… Outlawing fractional reserve banking…
Damn do I like the sound of that.
I dont want to defend FDR TOO much, but really, the weaksauce stuff he did do did almost get him overthrown by the corporate powers. If he pulled something off like this, the powers that were would NOT have been silent.
It was a common plan between the wars Mass. These days we have most of the housing we need, food production involves about 2% – so how are we struggling? What sort of fools could screw this up? There are some alternatives to Yves GS commentary including that it was only ever a power struggle between banks: http://digitalcommons.law.yale.edu/cgi/viewcontent.cgi?article=2796&context=fss_papers&sei-redir=1&referer=http%3A%2F%2Fscholar.google.co.uk%2Fscholar%3Fhl%3Den%26as_sdt%3D0%2C5%26q%3Dglass-steagall#search=%22glass-steagall%22
There’s a view with some ecology in it here:
https://edit.ethz.ch/er/publications/finance/Systemic_risk_in_banking_ecosystem_Nature_Jan11.pdf
In regulating the financial system, little effort has as yet been put into assessing the system-wide characteristics of the network, such as the diversity of its aggregate balance sheet and risk management models.Even less effort has been put into providing regulatory incentives to promote diversity of balance sheet structures, business models and risk management systems. In rebuilding and maintaining the financial system, this systemic diversity objective should probably be given much greater prominence by the regulatory community.
You have to be an economist to be fooled by any of this. The radical change would be to separate the money we use from banks entirely.
Decades ago the United States believed in anti-trust. The vertical integration of A&P was deemed anti-competitive. We had similar policies in place with regars to AT&T, IBM, Standard Oil ,etc. Those were good policies which contributed to the growth and stability of this country. Somehow someone decided those same principles do not apply to banking an finance. We’re now dealing with the repercussions of that thinking.