Really, Congress Won't Reinstitute Glass-Steagall

In one of the more ridiculous news stories today, House Majority Leader Steny Hoyer (D-MD) says some Congressmen are talking about reviving the Glass-Steagall Act, which was repealed in 1999. The Depression era legislation required investment and retail banking to remain separate. Repealing the law allowed "full service" banks like Citigroup and JP Morgan to come about over the last decade. I've already written about why bringing back this law is a misguided regulatory strategy. Of course, Washington isn't known for always being sensible, so that doesn't mean anything. Still, I think there's little chance this could actually happen.

Bloomberg reports what Hoyer said:

A renewal of the 1933 law "is certainly under discussion" by House members, Hoyer told reporters in Washington today. The Glass-Steagall law was repealed in 1999 to help pave the way for the formation of Citigroup Inc. by the $46 billion merger of Citicorp and Travelers Group Inc.

"As someone who voted to repeal Glass-Steagall, maybe that was a mistake," said Hoyer, a Maryland Democrat.

Hoyer made the comments when asked whether Congress and President Barack Obama's administration could do more to persuade banks to make more business loans and get credit flowing into the economy. Obama met yesterday with the chief executive officers of U.S. banks, urging them to lend more money.

Call me crazy, but that sounds like a threat. Is Hoyer saying that if big banks don't start lending, Congress might more realistically consider breaking them up? For starters, that would only bother a small handful of banks. But Washington would also be cutting off its nose to spite its face: such legislation would hardly get banks to lend more. For most of those big banks, the very reason they're doing well is because of their investment banking arms. Retail banking is still very much in turmoil compared to trading, issuing and advisory businesses. So if you slice off the struggling retail pieces, they'll probably lend even less.

In any case, it's more a threat than a promise. I'd be pretty surprised if the House actually had the votes to pass legislation to bring back Glass-Steagall. Remember, the House barely even passed its less controversial financial regulation last week. This suggestion would mark a far more involved systematic break-up of several major banks. And while it's at least metaphysically possible that this proposal could pass through the House, I'd be utterly shocked if the Senate had the votes. I doubt Hoyer's threat will make banks blink.

As mentioned, I've already argued against bringing back Glass-Steagall. It's a ridiculous notion that repealing the legislation caused the crisis and that reinstating it would help prevent another, so I won't go into that too much again here. Instead, I'll just defer to Ben Bernanke, also quoted by Bloomberg:

Even so, Fed Chairman Ben Bernanke told the Economic Club of New York on Nov. 16, "Plenty of firms got into trouble making regular commercial loans, and plenty of firms got into trouble in market-making activities."

"The separation of those two things per se would not necessarily lead to stability," Bernanke said.

Indeed, the banks that got into trouble weren't only those who took advantage of Glass-Steagall's repeal. On the retail side, big names like Washington Mutual and Wachovia didn't have any significant investment banking business, but essentially failed. So did over a hundred smaller regional retail banks. On the pure investment banking side, Bear Sterns, Lehman and Merrill Lynch were a few behemoths who didn't have a retail business, but collapsed nonetheless.

Breaking up some banks might make sense from a systemic risk standpoint, but doing so merely because they have both investment and retail banking is arbitrary. If a big bank contains risks that threaten the financial system that can only be contained if spread across several smaller institutions, then that's fine -- break them up. But don't just look for an easy way out that fails to address the actual problems that exist.