Economics 101: What is Glass Steagall??

 

The Glass-Steagall Act was enacted during the Great Depression. It protected bank depositors from the additional risks associated with security transactions. The act was dismantled in 1999. Consequently, the distinction between commercial banks and brokerage firms has blurred; many banks own brokerage firms and provide investment services.

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‘Shatterer of Glass-Steagall’ calls for its restoration

The former boss of giant U.S. bank Citigroup, Sanford (Sandy) Weill, who possesses a giant wooden plaque listing his accomplishments which includes the line, “The Shatterer of Glass-Steagall”, has shocked the banking world by calling for its restoration.

Weill is falling in with the global push to restore Glass-Steagall long associated with U.S. physical economist Lyndon LaRouche, which some of the leading bankers in Britain recently boosted following the revelations of 16 London banks flagrantly manipulating the benchmark London Interbank Offered Rate to rip off the world.

But it is Weill’s call that has shocked Wall Street, because he was the key lobbyist for the repeal of Glass-Steagall. In 1998 Greenspan granted a waiver to Travelers Insurance Company, then headed by Sanford Weill, to buy Citibank. Travelers owned Salomon Smith Barney, a large investment bank. The Travelers-Citibank merger, for the first time since the passage of Glass-Steagall in 1933, allowed a single bank holding company to own a commercial bank, an insurance company, and an investment bank. This waiver spelt the beginning of the end of Glass-Steagall [repealed a year later through the Gramm-Leach-Bliley Act, which Congressmen variously dubbed the Citi-Travellers Bill, or Sandy’s Bill], and the birth of institutions that are “too big to fail”.

“In the space of a few seconds, Sanford Weill disavowed the work of a lifetime,” reported the July 27 The Australian. “Mr Weill, who built up Citigroup into a banking behemoth … yesterday called for the break-up of the big banks,” the article continued.

“The stunning suggestion from the man who created Citigroup from the 1998 merger of Travelers and Citibank lit a bonfire under a simmering ‘too big to fail’ debate”, continued the Australian Financial Review of the same day. “The Citigroup merger required a waiver of the Glass-Steagall Act—which had prohibited such combinations since 1933—until the law could be repealed a year later, in 1999,” the Review revealed.

On July 25 American Banker Magazine reported that both Democratic and Republican congressmen were thunderstruck by Sandy Weill's comments, “suggesting a new openness to the argument that the nation’s largest banks should be broken up.” “It is absolutely huge that Sandy Weill has called for the break-up of the big banks,” one Democratic Representative was quoted saying.

The magazine was brave enough to acknowledge the heretofore lone voice of Lyndon LaRouche on the issue: “Supporters of Lyndon LaRouche have recently been distributing pamphlets outside the Capitol calling for the return of Glass-Steagall—a symbol of how politically marginal the debate about breaking up the big banks has been until now. …” [emphasis added] In a video interview, the magazine’s editor-in-chief observed, “One of the things that was really interesting about it was that it seemed that this was the moment that actually the breakup the big banks movement started to get some traction, at least in the popular press, maybe in Washington.”

The July 26 New York Times editorial did their own Olympic-quality backflip on Glass-Steagall, following Weill’s, declaring, “While we are on this subject, add The New York Times editorial page to the list of the converted. We forcefully advocated the repeal of the Glass-Steagall Act. … Having seen the results of this sweeping deregulation, we now think we were wrong to have supported it.”

The Glass-Steagall debate has also broken into popular entertainment, featuring in an episode of the new U.S. docudrama Newsroom, in which a character offers the following excellent explanation of Glass-Steagall: “Congress wanted to put a firewall in between the investment banks and the commercial banks. They wanted to make sure that Wall Street could melt to the ground, and the commercial banks wouldn’t be touched. They passed a law, the Glass-Steagall Act: Now, you could be Gordon Gekko [tycoon from movie ‘Wall Street’] or George Bailey [community banker from ‘It’s a Wonderful Life’], but you couldn’t be both.” [Emphasis added]

LaRouche affirmed that what began a few weeks ago in Britain, has now exploded onto the front burner in the United States. “These are people who have chosen the future,” he said. “They have changed their direction of commitment, to support Glass-Steagall, when they had been, up to that point, exactly in the opposite direction.”

The restoration of Glass-Steagall is the centerpiece of the CEC’s resolution, The Future of Australia: Develop or Die.As the CEC exposed last week, the corruption of the financial system on display in the manipulation of the LIBOR reaches deep into Australia, through the direct impact of the LIBOR itself and the possible manipulation of Australia’s LIBOR-equivalent, the BBSW. This flagrant corruption goes hand in hand with the deregulation of the economy kick-started in 1983 by Hawke and Keating and continued by their Liberal accomplices. Only implementing the Glass-Steagall principle can reverse the policies that opened up the financial affairs of ordinary Australians and essential government services to undisguised looting by the global banking cartel. 

The banks that were at the forefront of the crisis – Bear Stearns, Lehman Brothers, Washington Mutual, Countrywide – were either pure investment banks or pure commercial banks. The ability to merge the two types was crucial in mounting swift rescues to stabilise the system – such as the acquisition of Bear Stearns by JP Morgan and of Merrill Lynch by Bank of America.

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Why I was won over by Glass Stegall….

By Luigi Zingales

There are certainly better ways to deal with excessive risk-taking behaviour by banks, but we must not allow the perfect to become the enemy of the good. In the absence of these better mechanisms, it makes perfect economic sense to restrict commercial banks’ investments in very risky activities, because their deposits are insured. Short of removing that insurance – and I doubt commercial banks are ready for that – restricting the set of activities they undertake is the simplest way to cope with the burden that banks can impose on taxpayers.

The Volcker rule, which prohibits banks from engaging in proprietary trading but allows them to put their principal at risk, is not a good substitute. Proprietary trading is when a bank invests in stock hoping that its price will go up. A bank engages in principal trading when it buys a stock from a client as a service to that client, who wants to unload his position quickly. The difference is therefore one only of intentions, which are impossible to detect, since any transaction involves two consenting parties.

The second reason why Glass- Steagall won me over was its simplicity. The Glass-Steagall Act was just 37 pages long. The so-called Volcker rule has been transformed into 298 pages of mumbo jumbo, which will require armies of lawyers to interpret. The simpler a rule is, the fewer provisions there are and the less it costs to enforce them. The simpler it is, the easier it is for voters to understand and voice their opinions accordingly. Finally, the simpler it is, the more difficult it is for someone with vested interests to get away with distorting some obscure facet.

The third reason why I came to support Glass-Steagall was because I realised it was not simply a coincidence that we witnessed a prospering of securities markets and the blossoming of new ones (options and futures markets) while Glass-Steagall was in place, but since its repeal have seen a demise of public equity markets and an explosion of opaque over-the-counter ones.

To function properly markets need a large number of independent traders. The separation between commercial and investment banking deprived investment banks of access to cheap funds (in the form of deposits), forcing them to limit their size and the size of their bets. These limitations increased the number of market participants, making markets more liquid. With the repeal of Glass-Steagall, investment banks exploded in size and so did their market power. As a result, the new financial instruments (such as credit default swaps) developed in an opaque over-the-counter market populated by a few powerful dealers, rather than in a well regulated and transparent public market.

The separation between investment and commercial banking also helps make the financial system more resilient. After the 1987 stock market crash, the economy was unaffected because commercial banks were untouched by plummeting equity prices. During the 1990-91 banking crisis, securities markets helped alleviate the credit crunch because they were unaffected by the banking crisis. By contrast, in 2008 the banking crisis and the stock market crisis infected each other, pulling down the entire economy.

Last but not least, Glass-Steagall helped restrain the political power of banks. Under the old regime, commercial banks, investment banks and insurance companies had different agendas, so their lobbying efforts tended to offset one another. But after the restrictions ended, the interests of all the major players were aligned. This gave the industry disproportionate power in shaping the political agenda. This excessive power has damaged not only the economy but the financial sector itself. One way to combat this excessive power, if only partially, is to bring Glass-Steagall back.

The writer is a professor at the University of Chicago Booth School of Business and author of ‘A Capitalism for the People: Recapturing the Lost Genius of American Prosperity’, published this week

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