Volcker's Quest To Reinstate Glass-Steagall

The New York Times today has an article about former Federal Reserve Chairman Paul Volcker's crusade to bring back the Glass-Steagall Act. Obama isn't listening. The Act used to keep separate commercial and investment banking activities. The Gramm-Leach-Bliley Act of 1999 repealed it. Consequently "full service" banking behemoths like Citigroup and JP Morgan came to be, now allowed to participate in every financial activity imaginable. Many, including Volcker, believe this was a big mistake, and one of the causes of the financial crisis. I don't see it. At all. The loudest argument to bring back Glass-Steagall usually goes something like this: Depository institutions (commercial banks) need to be very safe and stable. If you allow investment banks to take big risks with those deposits, bad things can happen. So how might this have played a part in the financial crisis? Here's Volcker's position, via the NY Times:

He wants the nation's banks to be prohibited from owning and trading risky securities, the very practice that got the biggest ones into deep trouble in 2008.

Now let's take a step back. What are these risky securities we're talking about? They're bonds backed by real estate -- originated by commercial banks. So really, it was the commercial banks that took the crazy risks that almost broke the economy. If there was never securitization, and the same subprime loans were made, then we'd have very, very sick depository institutions, but investment banks would have been largely unscathed. Of course, there was securitization, and that was done by the investment banks. Where might Glass-Steagall have helped here? Well, it wouldn't have. Securitization existed before the Act was repealed, and it would exist if it's brought back. Commercial banks can still sell mortgages into giant pools for investment banks to make securities out of, with or without the mortgage originators and bankers living under the same umbrella. Commercial banks also still would have retained lots of their mortgage exposure, and still been quite sick. Just ask Countrywide. Let me be clear: you can debate the pros and cons of Glass-Steagall in a vacuum. I think there are some decent arguments for bringing it back, but none of them relate to the causes of the financial crisis. If they did, then only the big "full service" banks would be sick and over two hundred smaller banks that had no investment banking arm wouldn't also be ailing. Finally there's the question of why Obama isn't listening to Volcker. I can come up with a number of theories. Maybe it's as simple as Obama not agreeing. Maybe he's waiting for the right moment to hold this possibility over the heads of big banks to get them to concede other regulatory aspirations. Maybe he worries about losing campaign contributions from big bank execs. But whatever his reason, I think he's right to be ignoring this suggestion at this time. Even if it has merit, it shouldn't be an immediate regulatory priority since it wasn't a cause of the crisis.

This article available online at:

http://www.theatlantic.com/business/archive/2009/10/volckers-quest-to-reinstate-glass-steagall/28759/