Inside Financial Services

The Irrelevance of Glass-Steagall 2.0

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I’m a reasonably conservative Republican, but am nonetheless having trouble thinking of a single idea John McCain has ever had that I actually agreed with. The latest is his proposal (which he’s putting forth with Elizabeth Warren) to restore a Glass-Steagall-ish separation between lending and trading in the banking industry, to prevent the next financial crisis. Or, as Warren hyperventilated to the New York Times last week, “The biggest banks continue to engage in dangerous high-risk practices that could once again put our economy at risk,”

Phooey. I understand that the plan is a publicity stunt by two major prima donnas that’s going nowhere, and I’ll grant, too, that this isn’t the absolutely worst idea that McCain ever had (that would be his entire 2008 presidential campaign). But this notion that, had Glass-Steagall been in place during the housing boom last decade, that the subsequent financial crisis would have been avoided is completely and utterly preposterous. As I say, typical McCain.

To begin with, it wasn’t any sort of mysterious trading by the banks that caused all the trouble. It was bad lending. Too many banks lent too much money to too many borrowers (subprime mortgage borrowers, in this case) who couldn’t afford to pay it back. When everyone realized that so many institutions were loaded down with the same bad paper, confidence in the system evaporated, interbank lending basically stopped, and the financial system nearly keeled over. Trading had nothing to do with it.

So it was credit problem, and extending credit, I hasten to remind Sens. McCain and Warren, is what banks do. If anything (as Dick Kovacevich and others never tire of reminding bank-bashers) allowing banks to offer financial services in addition to lending is a healthy diversification. One of the reasons companies such as Wells Fargo and JPMorgan Chase skated through the crisis so well is that their non-lending businesses held up even as credit costs ballooned.

Beliefs of the Glass-Steagall cult notwithstanding, the fact is that every major banking crackup in memory came about for the same reason: bad lending. Not derivatives trading. Not prop trading. Not securities underwriting. It was the lending that did it, to (depending on which crackup you’re talking about) developing countries, energy companies, real estate developers, you name it. In this case, it was mortgage borrowers. And contrary to what McCain and Warren believe, having a Glass-Steagall-like wall in place wouldn’t have done a thing to prevent the mess, nor will it prevent the next one. There are plenty of needed reforms I can think of that would make the banking system safer. This isn’t one of them.

What do you think? Let me know!

27 Responses to “The Irrelevance of Glass-Steagall 2.0”

  1. Jerry

    The solution to “TOO BIG TO FAIL” is to restricts all U.S. Banks to doing business and having branch offfices in only 10 adjacent states. Phase in over 5 or 7 years.

  2. rivvir

    Perhaps. But perhaps because the banks were also involved in the derivatives trading they were making those bad loans to support the derivatives action. No loans, no derivatives income. No? That’s what greed does, it causes blindness. No derivatives involvement then no need to go blind.

  3. Jim

    I don’t know that I’d ever seen “John McCain” and “conservative” used in the same sentence

  4. Abe Kohen

    Heck, I’m a registered Democrat, but a fiscal conservative. Doesn’t matter whether it was bad lending or CDOs that caused the market breakdown. What matters is that banks like BofA/BAML need to know what business they are in. Are they lenders? Are they mortgage speculators? Should they be issuing garbage paper, aka derivatives, which S&P and Moodys rated AAA? BofA/Countrywide? Customers need to know their money won’t be MF Globaled. Yes, these can happen even with Glass-Steagall, but as an educated bet it would be less likely if banks and customers knew what they were getting into,

  5. Bill Dunnell

    Tom, I think Liz Warren’s main concern is that deposits are being concentrated in bigger banks even more so since the crisis with help from the dodd frank bill. She does have a point in that massive deposits concentrated in a few banks is not good. I agree with you that glass-steagall 2.0 is not the answer but what is? What is the best way to stop or slow this trend and encourage stronger community banking?

  6. O'Kane

    So much for your paranoia about McCain. Your conclusions about financial crises ignore that bad lending and bad whatever really begins and ends with bad, irresponsible, greedy and self-serving managements, boards of directors and regulatory authorities.

  7. grover13

    “it wasn’t any sort of mysterious trading by the banks that caused all the trouble….Trading had nothing to do with it.”

    Um, Tom, were you actually ALIVE during the last decade? Trading had EVERYTHING to do with it.

    Prior to the fall of Glass-Steagall you could either make loans, or you could trade and securitize loans. One or the other. You couldn’t do both.

    Only one year after Graham-Leach-Bliley was passed, subprime volume in 2000 quadrupled from the previous year. That’s because Wall Street got what they wanted- they could now originate their own loans to feed their own trading pipelines. Three years later, the rise of Alt-A lending (read: No-Doc, Ninja, and Pay Option Arms) began their meteoric rise.

    All of the problems were in loans that were securitized and sold (i.e. TRADED). Banks deluded themselves into believing that because they had securitized the loans, they were insulated from performance. And hey, if performance was poor, they had CDS derivatives as a hedge. We all know how that worked out: the derivatives became worthless, because the company that issued most of them (AIG) couldn’t pay up when the time came. And soon after, the repurchases and lawsuits came after the originators- which they never thought was a possibility.

    You say it was bad loans on the books that caused failures? Really?

    How many loans did Lehman own?
    How many loans did Bear Stearns own?
    How many loans did Merryl Lynch own?

    Had Glass Steagall remained in place, and banks had to retain credit risk on the loans they made, all of the ridiculous high-risk lending never would have happened in the first place…..the rise of these programs only came to pass because of the illusion that the risk could be traded away.

    It’s funny. The mortgage world- in fact, the entire banking system- hummed along just fine for sixty years since Glass Steagall was originally passed. Once it was repealed, the system took less than a decade to blow themselves up, and p

  8. Jim

    I don’t know that I’d ever seen “John McCain” and “conservative” used in the same sentence

  9. Jayhawk

    why dont you list your ideas—instead of vague referemces

  10. Jayhawk

    why don’t you list your ideas —instead of vague references

  11. Hear me now

    Let’s not forget what really got us here in the first place. President Clinton saying everyone should own a home and President Bush making it easier to get financing with the help of Congress. So know Warren and McCain think they are trying to prevent themselves and Congress from screwing up again by doing just that…..screwing up again by trying to bring us back to yesteryear, I wish Congress would come up with something new that is well thought out instead of the same old junk.

  12. DSB

    There was no bigger legislative disaster than Phil Gramm of Gramm-Leach-Bliley infamy. Everything Gramm touched was a disaster and even the folks he did the bidding for – Sandy Weill and John Reed – believe it was a mistake. As for lending being the source of the problem that is somewhat correct but really misses the point of the financial crisis. In the late nineties and early aughts the bankers made loans that complied with a somewhat small box dictated by “investors” – the people buying the loans originated by the banks. As the aughts wore on the investors box became bigger. Ultimately the banking and shadow banking industries were incapable of supplying enough loans to feed the securitization machine so they created synthetic mortgages to continue feeding the machine to the point where the machine broke and the financial system was on the brink of collapse. So from this perspective it was the investment bankers driving the lending. It is why the investment banks bought mortgage operations to feed their machines to crank out fees, profits and bonuses. It is these hybrid organizations – JPM, C, BAC, GS, DB – that have trillions of dollars of derivatives on their commercial bank balance sheets supported with FDIC insured deposits. Investment banks do nothing for commercial/retail banks except increase assets so the CEO gets paid more.

  13. A Concerned Citizen

    The Glass-Steagall act is exactly what we need to bring the major banks back in line. They have run rough shod over every regulation whenever possible. They shoud stick to banking only and not get their fingers into every conceivable investment vehicle outside of simple banking. Do you have to be hit over the head many more times to see the damsge they are causing.

  14. former VP, finance

    Too bad this guy doesn’t have a mpore complete understanding of UNIVERSAL banking and human nature!!
    But in the “say anything” world of the First Amendment, it’s possible that he understand it perfectly and is simply trying to add confusion.

  15. Jim in Pittsburgh

    How about insisting that a bank keep and service every mortgage it makes? No more bad loans — voila!

  16. Jim M.

    From Wikipedia . . . On July 25, 2012, (Sandy I.) Weill apparently reversed course on the financial supermarket and stated “What we should probably do is go and split up investment banking from banking, have banks be deposit takers, have banks make commercial loans and real estate loans, have banks do something that’s not going to risk the taxpayer dollars, that’s not too big to fail,”

    From 7/17/13 WSJ . . . The Federal Energy Regulatory Commission is getting ready to levy a fine of $600 million – $1 billion on JPMChase for manipulating energy prices! What’s JPMC doing in selling energy . . . ah, yes . . . a benefit from the Bear Stearns rescue . . . see the WSJ article.

    JPMC could have given more management focus to making good mortgage loans if it hadn’t a lot of nontraditional banking businesses to manage that they had no business being it.

    This is probably the only thing I’d agree with Elizabeth Warren on . . . just her proposal . . . not any of her socialistic reasoning.

  17. Absurd

    “I’m a reasonably conservative Republican”

    That is preposterous, I literally chocked laughing at that. You only say that because the dems continue to destroy our prosperity and the chances of the little guy to succeed independently to protect their special interests that vote for them.

  18. Absurd

    “I’m a reasonably conservative Republican”

    That is preposterous, I literally chocked laughing at that. You only say that because the dems continue to destroy our prosperity and the chances of the little guy to succeed independently to protect their special interests that vote for them.

  19. JRG

    Tom, please explain why it ok to take government insured deposits fed funds or other short term funding available only to banks and engage in prop.trading. This would be prevented under Warren’s proposal.

  20. Daniel

    Disagree. AIG and all the big investment banks (except for Lehman and Bear Stearns) were bailed out and it was not their lending but being a conduit for the junk bonds that they made a fortune on and the taxpayer got STUCK with their greedy capital shortfall.

  21. JohnL

    Most everyone here is missing the critical point. What was the main underlying factor in that “bad lending?”
    The government involvement in the housing market. No one in their right mind would engage in bad lending unless–
    A) Forced to by threat of legal action by…the government.
    B) cockamamie schemes like too big to fail implemented by?…Drum roll…the government.

    The lending market was commandeered by a government intent on “social justice” and “spreading the wealth around.” (there are votes in a chicken in every pot and a roof over every head). “Don’t worry about credit worthiness…we got your back. When things go bad we’ll just print some money and give it to you (after we run outta tax dollars of course).

    When you remove risk from any capitalist endeavor you end up in trouble!

    While we all get snookered by the Government sleight of hand and look at banks and Wall Street execs we miss the real problem. Where was any government oversight during the “crisis?” Where were Barney and Chris? (busy getting their “friends and families special loans from Angelo!). You can’t make this stuff up!

    So the same people who sent Barney to watch over our economy have given us Liz (as a Native American she probably qualifies for a nice government backed low interest housing loan).

    Like I said, you can’t make this stuff up!

  22. oy

    How can an industry analyst be so far off base? I go with grover13′s analysis. Glass-Steagall 2.0 may not be the solution to all our problems – what is? – but it is a step in the right direction. Universal banking is a disaster just waiting to happen.

  23. huh?

    Even if we accept your argument that the crisis was narrowly focused around bad lending, clearly the derivatives activities amplified the crisis.

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