Glass-Steagall Repeal Saved Us From MUCH Worse in 2008

Glass-Steagall Repeal Saved Us From MUCH Worse in 2008
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Has the notion that the seeds for the 2008 Great Recession were sowed with the scrapping of the Glass-Steagall Act’s firewall between commercial banks and securities activities become entrenched as an accepted part of conventional wisdom? The popular misconception may become more than just a debating point for those who favor increased regulation of financial markets. By setting the stage for restoring the Glass-Steagall wall, this myth could end up undermining Wall Street’s place as the leader in world finance. And with that, damage the U.S. economy.

Financial columnist Jonathon Trugman repeated the mantra in Sunday’s New York Post. In a passing critique of former Goldman Sachs CEO Robert Rubin, Trugman mentioned that gutting the law “helped bring on the mortgage crisis in 2008” – in a subordinate clause as though it is a subordinate thought, to be accepted with little or no debate. But maintaining an integrated banking system is a primary need.

In the kind of bipartisanship that many pine for today, large majorities in both parties were able to agree on the need to eliminate the wall between banking services. Why? Because large majorities in both parties recognized the importance of allowing U.S. financial institutions the opportunity to build the scale, scope and global reach required to compete on the world stage. The purpose of banks is to help bring together people who have capital with people who are able to make use of it to create wealth. Overhauling Glass-Steagall encouraged the financial innovations that facilitated that process, allowing businesses and individuals access to capital more efficiently than it would otherwise be available. Banking clients, especially large, globalized ones, want to have access to as many products as possible, backed by the most up-to-date technology –  innovation that is made possible only through scale. Clients want and need their banks to provide seamless execution. They want and need the one-stop service that allows them to get financing, advice, and brokerage and investment services under one roof. Those who would reverse the calendar and restore 1930s-style banking regulation might just as well try to bring back the Packard. Banking customer needs have changed and grown, new products backed by new technologies have been designed to meet them. When Glass-Steagall was passed over 80 years ago, splitting up a bank was like dividing an apple pie in half. Today, trying to hive off commercial from investment banking would be more like pulling apart a layer cake – vertically.

In fact, knocking down the walls between financial services didn’t help cause the financial meltdown so much as help contain it. None of the institutions that ended up doing the most to prompt the financial meltdown was a financial hybrid. Most of the problems that sprung up among financial institutions in 2008 were among pure-play institutions, primarily investment banks – and their boutique activities would not have been circumscribed by the Glass-Steagall firewall. In fact, knocking down that legal wall actually made it possible for several investment banks to be rescued. If Glass-Steagall had not been changed, the commercial bank J.P. Morgan Chase would not have been able to rescue the investment bank Bear Sterns, and commercial Bank of America would not have been able to rescue Merrill Lynch. If Glass-Steagall’s firewall had still been in place, we might have seen the impact of the Lehman collapse times three.

Moreover, if allowing financial institutions to have both commercial and investment banking divisions threatens the security of the banking system, why was Canada almost the only country in the G7 to get through the 2008 crisis without losing a financial institution? Canada knocked down the walls barring vertical integration between commercial and investment banking (and insurance) in the 1990s, and hasn’t required banks to shed any of their activities since.

Splitting banks up doesn’t prevent them from being ‘too big to fail.’ If J.P. Morgan Chase, Citi, and Bank of America were forced to split off their investment banking from their commercial banking arms, there would simply be six institutions ‘too big to fail’ where now there are three. Most who wish to put the Glass-Steagall wall back in place long for a solid guarantee of no future financial crises. But that is futile. Capitalism without risk is oxymoronic, and trying to eliminate it is like trying to become a little bit pregnant. Rather than attempt to prevent all risks, it makes more sense to enhance our capacity to recover from them. That requires greater ability to create wealth, not less.

Allan Golombek is a Senior Director at the White House Writers Group. 

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