Clear as Glass (Steagall)

Off all the most bizarre statements running around about this crisis, the most bizarre is the shockingly common belief on the left that this can somehow be traced back to the Gramm-Leach-Bliley act, which "repealed" Glass-Steagall. (The equivalent, not-quite-as-loony belief on the right is that if we hadn't had such tough redlining laws, or such deep government interest in expanding homeownership, this wouldn't have happened).  This is wrong in so many ways that one hardly knows where to start.

Let's start with the history:  there were actually two Glass-Steagall acts, but what we're generally referring to is the second one, passed in 1933, which did a number of things.

  • It regulated interest rates, including setting a rate of zero on demand deposits.  This was rolled back decades ago, which is why you now get interest on your checking account, and banks strive to offer you an attractive interest rate rather than a free toaster when you open an account with them.
  • It established the FDIC to insure bank deposits.  Last time I looked, the FDIC was still there, keeping my $7.67 safe from harm.
  • It separated investment banking and commercial banking, which is why Morgan Stanley and JP Morgan are two different institutions.  This was effectively dead letter when Traveler's bought Citigroup in 1998, but Gramm-Leach-Bliley officially repealed this provision in 1999.

The argument is that this was a bad idea because Glass-Steagall wisely prevented commercial banks from mad speculation.   This is what you might call "Folk Economics"--wrapped in the lurid lore of the New Deal and very superficially appealling, it is close to an axiom of faith for many on the left.  Sadly, it is simply wrong, as Alex Tabarrok ably explains:

Given a history like this people wonder how repealing the law could have been a good thing.  But a significant academic literature has investigated these claims and rejected them.  Eugene White, for example, found that national banks with security affiliates were much less likely to fail than banks without affiliates.  Randall Kroszner (now at the Fed.) and Raghuram Rajan found that (jstor) securities issued by unified banks were (ex-post) of higher quality that those issued by investment banks.  A powerful book by George Benston went through the entire Pecora hearings which supposedly revealed the problems with unified banking and found them to be a complete sham.  My colleague, Carlos Ramirez later showed that the separation of commercial and investment banking increased the cost of external finance (jstor).  Finally, my own work (pdf) unearthed the real reasons for the separation in a titanic battle between the Morgans and Rockefellers.

Yet this meme keeps coming back and back, in my comments and elsewherePaul Krugman and Daniel Gross are too chicken to outright claim that the "repeal" caused this mess, but they sure do strenuously imply it.

They can't say it more directly because it's moronic.  Even if you ignore the economic history indicating that Glass-Steagall didn't help the crisis it was meant to solve--even if you assume, arguendo, that the repeal was a bad idea--there's simply no logical reason to believe it had anything to do with the current mess.

Securitization was not introduced in the 1990s; it was invented in the 1970s and became popular in the 1980s, as chronicled in Liar's Poker.   (As an aside, if you haven't read it, you really must.  Especially now).

GLB had nothing to do with either lending standards at commercial banks, or leverage ratios at broker-dealers, the two most plausible candidates for regulatory failure here.

Most importantly, commercial banks are not the main problems.  If Glass-Steagall's repeal had meaningfully contributed to this crisis, we should see the failures concentrated among megabanks where speculation put deposits at risk.  Instead we see the exact opposite:  the failures are among either commercial banks with no significant investment arm (Washington Mutual, Countrywide), or standalone investment banks.  It is the diversified financial institutions that are riding to the rescue.