Republicans Repealed Glass-Steagall -- Economic Crisis Results

When Republicans repealed the Glass-Steagall Act, they planted the seed that grew into the housing bubble crash and the need to bail out Wall Street, and the Democrats have been left to reap that crop.

One doesn't have to be pro-Democrat to be anti-Republican. There is a lot of good - and bad, in both parties, so the more accurate finger-wagger should address the nuts-and-bolts instead of the whole engine. Obama and the Democrats are getting the blame for not fixing the current economic crisis - and it's true, they aren't, but it's also true the current crisis wasn't entirely of their making. They helped in many ways, but it was the removal of the safety barriers in the Banking Act of 1933, (Glass-Steagall), that allowed our financial markets to careen off course.

The Glass/Steagall Act was officially - The Banking Act of 1933, and it had several components; it established the FDIC, (Federal Deposit Insurance Corporation), and introduced banking reforms that were designed to control speculation by banks and other financial institutions that controlled deposit and investment monies. It was essentially a consumer protection bill designed to keep different financial market functions - commercial and investment, separate. Banks held depositor's money and the act was intended to keep it separate from the riskier investment markets. If depositors wanted to be investors, they could do so in the investment markets, but if not, they didn't have to be worried about their money being at risk through their banking institution's actions. It was a sound policy that worked.

As our financial markets and institutions grew and began becoming more involved in global business, the Glass-Steagall Act restricted them from doing some of the things they wanted to do. Banks saw all the money to be made in the insurance and investment markets, and those markets, with a gleam in their eye, saw a huge pool of depositor's money in the banks that they could use for even more investment and speculation activities - and the influence-peddling and favor-buying began.

The financial markets of other nations weren't restricted by rules like the Glass-Steagall act, so the U.S. markets started pushing the "we need freedom to compete" mantra to any politician they could get to listen. They started this campaign around 1980, and did manage to get a few restrictions lifted, and by 1987 there was enough political pressure to warrant a Congressional Research Service report which explored the case for preserving Glass–Steagall as well as the case against preserving the act.

The essence of their report was this:

In favor of preserving the Glass-Steagall Act

1. Prevented conflicts of interest that could characterize the; granting of credit, lending and the use of credit, and investing by the same entity - which had led to abuses that originally produced the Act. In other words, you might not quite qualify for a particular loan, bit if you might use that loan for another financial activity the bank has a piece of, or makes a commission from, then, well - OK you do qualify after all. And vice-versa.
2. Because depository institutions possess enormous financial power, by virtue of their control of other people’s money; its extent must be limited to ensure soundness and competition in the market for funds, whether loans or investments. Meaning - with all that depositors money available, banks could act the part of the Big Dog and influence the level of the playing field for all participants. Sound prescient?
3. Securities activities can be risky, leading to enormous losses. Such losses could threaten the integrity of deposits. In turn, the Government insures deposits and could be required to pay large sums if depository institutions were to collapse as the result of securities losses. In a nutshell - banks would be gambling with other people's money, and Uncle Sam might get left holding the bag if they failed. Once more, those were pretty accurate crystal-ball gazers back in 1932.
4. Depository institutions are supposed to be managed to limit risk. Their managers thus may not be qualified to operate prudently in more speculative securities businesses. An example is the crash of real estate investment trusts sponsored by bank holding companies (savings & Loans in the 1970s and 1980s). Same note as for #3

Looking at today's economic crisis in the financial markets, and the government bailouts involved - those look like some very accurate reasons for keeping the Banking Act in place.

Their conclusions against preserving the Glass-Steagall Act:

1. Depository institutions would now operate in “deregulated” financial markets, where distinctions between loans, securities, and deposits are not very clear. U.S. Financial markets are losing market shares to securities firms that are not so strictly regulated, and to foreign financial institutions operating without much restriction from the Act. - In other words, they could not compete as profitably in the global financial markets as foreign financial markets could. They needed to be able to do things that were more of a risk to depositor's money than the act allowed.
2. Conflicts of interest can be prevented by enforcing legislation against them, and by separating the lending and credit functions through forming distinctly separate subsidiaries of financial firms. -- If is difficult here to refrain from using a colloquialism such as; Yeah, right, suuurrre. That will work.
3. The securities activities that depository institutions are seeking are both low-risk by their very nature, and would reduce the total risk of organizations offering them – by diversification. -- Remember, this report was completed in 1987. It may not be fair of us to so quickly say - Poppycock! We have the advantage of hindsight.
4. In much of the rest of the world, depository institutions operate simultaneously and successfully in both banking and securities markets. Lessons learned from their experience can be applied to our national financial structure and regulation. -- Apparently those lessons weren't learned - as illustrated by the global financial crisis that is currently occurring. And which was beginning to show signs of failure before the U.S. crisis fully developed. Financial experts and economists were warning the U.S. markets as early as 2001.

As mentioned, political pressure, fueled by Wall Street lobbyists and influence-peddlers had been building since 1980, but it went into full-combat mode in 1996 when what was then CitiCorp bought-out and merged with Travelers Group, an Insurance company, Technically this transaction was illegal under the Glass-Steagall Act, but sensing the direction of the political winds, (or should that be "scent of big money"), the Federal Reserve gave Citigroup a temporary waiver in September 1998. A 2-year waiver that would allow the transaction to stand while the process of repealing Glass-Steagall matured.

Enter the Republicans. Senator Phil Gramm, (R-TX), House Representative Jim Leach (R-IA), and Rep. Thomas Bliley, (R-VA), Chairman of the House Commerce Committee. They sponsored a repeal bill called the Gramm–Leach–Bliley Act (GLB), also known as the Financial Services Modernization Act of 1999. The bill passed the Senate along party lines, 54–44, with only one Democrat voting with the Republicans. The House vote was more bi-partisan, 343-86.

Done. Let the games begin. Actually the Gramm-Leach-Bliley Act only repealed one part of the Glass-Steagall Act - the part that prohibited any one institution from acting as any combination of an investment bank, a commercial bank, and an insurance company. But that is the one Wall Street needed to be free to operate as they pleased. For instance it allowed a type of activity that is currently in the news - a banker's wife owning a banking holding company that the banker still could not technically own or control. Does not seem to be much of a secret though.

Here is another example of hindsight validating the accuracy of opponent's arguments. During debate in the House of Representatives, in 1999, Rep. John Dingell, Democrat of Michigan, argued that the bill would result in banks becoming "too big to fail." Dingell further argued that this would necessarily result in a bailout by the Federal Government. Does that sound like T.A.R.P.?

Although it was the Republicans that set the stage for the current economic debacle, the Democrats aren't blameless. They saw this as just as much of an opportunity to push their social engineering agenda as Big Money did for its profits. After the bill was sent to a conference committee to work out the differences between the Senate and House versions, Democrats agreed to support the bill if Republicans agreed to strengthen provisions of the Community Reinvestment Act. Which contained the legislation that pushed mortgage lenders to relax mortgage loan requirements so more low-income applicants could qualify. Things like allowing Food Stamps to be counted as income toward qualifying for the loans.

It was also a Democratic President that signed the bill into law - Bill Clinton. He could vetoed the bill, without the concern of a Republican override - they did not have the votes without Democrat support.

On one hand, it is almost eerie how prescient the original sponsors of the Banking Act of 1933, and the opponents of its repeal in 1999 were. On the other hand, the power of Big Money has always been recognized for the danger it poses. The irony is that so many from both sides of the political spectrum feel justified to stand tall and righteously point their fingers and shout - It's your fault!

In defense of the repeal

In defense of the repeal, Gramm, the primary author of the Act offered this statement:

"If GLB was the problem, the crisis would have been expected to have originated in Europe where they never had Glass–Steagall requirements to begin with. Also, the financial firms that failed in this crisis, like Lehman, were the least diversified and the ones that survived, like J.P. Morgan, were the most diversified. Moreover, GLB didn't deregulate anything. It established the Federal Reserve as a super-regulator, overseeing all Financial Services Holding Companies. All activities of financial institutions continued to be regulated on a functional basis by the regulators that had regulated those activities prior to GLB."

Also, according to a 2009 policy report from the libertarian Cato Institute, critics of the legislation feared that, with the allowance for mergers between investment and commercial banks, GLB allowed the newly-merged banks to take on riskier investments while at the same time removing any requirements to maintain enough equity, exposing the assets of its banking customers. The report claimed that, prior to the passage of GLB in 1999, investment banks were already capable of holding and trading the very financial assets claimed to be the cause of the mortgage crisis, and were also already able to keep their books as they had. It concluded that greater access to investment capital as many investment banks went public on the market explains the shift in their holdings to trading portfolios.The report noted that after GLB passed, most investment banks did not merge with depository commercial banks, and that in fact, the few banks that did merge weathered the crisis better than those that did not.

Bill Clinton, as well as economists Brad DeLong and Tyler Cowen have all argued that the Gramm–Leach–Bliley Act softened the impact of the crisis. Atlantic Monthly columnist Megan McArdle has argued that if the act was "part of the problem, it would be the commercial banks, not the investment banks, that were in trouble" and repeal would not have helped the situation. An article in the conservative publication, National Review, has made the same argument.

This defense stems primarily from involved parties defending their involvement. And there are authoritative economists and financial market experts that disagree with those defense arguments. Somehow the reality of the situation, and the prophesies of its opponents seem to stand against these defensive arguments.

But as always, it's the reader's mind, so the choice to agree or disagree is theirs alone.

• GA Anderson - on Politics

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