Democrats and Republicans seem to have a difficult time agreeing on just about anything these days. But one place where they have found common ground: the now defunct Glass-Steagall Act—which once kept commercial and investment banking separate. (It did so by preventing investment banks from taking deposits and mandating that only 10 percent of a commercial bank’s income could come from securities.) The post-Great Depression financial regulation was passed in 1933, and was effectively repealed in 1999.
Both presidential candidates, Hillary Clinton and Donald Trump, have included plans to reintroduce the bill in their economic platforms. The argument for the act is that it could have prevented (or at least dampened) the 2008 financial crisis, and that reinstating it could ward off future ones. Is that the case?
The Atlantic’s editors reached out to economists and experts in financial regulation to ask them why Glass-Steagall is seeing renewed popularity right now, and what they think would make America’s financial system safer in the future.
The responses below have been lightly edited for clarity.
Robert Reich, a professor of public policy at the University of California, Berkeley, and former Secretary of Labor from 1993 to 1997
Some argue Glass-Steagall wouldn’t have prevented the 2008 crisis because the real culprits were non-banks like Lehman Brothers and Bear Stearns. But that's baloney. These non-banks got their funding from the big banks in the form of lines of credit, mortgages, and repurchase agreements. If the big banks hadn’t provided them the money, the non-banks wouldn’t have got into trouble. And why were the banks able to give them easy credit on bad collateral? Because Glass-Steagall was gone.
I’ve also heard bank executives claim there’s no reason to resurrect Glass-Steagall, because none of the big banks actually failed. This is like arguing lifeguards are no longer necessary at beaches where no one has drowned. It ignores the fact that the big banks were bailed out. If the government hadn’t thrown them lifelines, many would have gone under. Their balance sheets were full of junky paper, non-performing loans, and worthless derivatives. They were bailed out because they were too-big-to-fail. And the reason for resurrecting Glass-Steagall is we don’t want to go through that ever again.
My conclusion: We need to resurrect Glass-Steagall. We also need to bust up the big too-big-to-fail banks. Their platoons of lawyers are already busily rolling back Dodd-Frank.
Stephen G. Cecchetti, a professor at Brandeis International Business School and Kermit Schoenholtz, the director of the Center for Global Economy and Business at NYU Stern School of Business
In the aftermath of the financial crisis of 2007-2009, voters want assurance that the U.S. financial system is safe and that the government will not be tempted again to bail out the country’s banks and bankers. Some people blame the crisis on the 1999 repeal of the 1934 Glass-Steagall Act, which had segmented investment and commercial banking in an effort to limit risk taking. In our view, however, separating investment and commercial banking would not have prevented the financial crisis, and its re-imposition will not prevent the next one. What made the crisis so deep were practices that were completely legal and have little to do with Glass-Steagall. For example, many financial institutions that depended heavily on short-term funding operated with very few liquid assets and almost no capital. Some of the largest firms also used derivatives that allowed them to conceal extraordinary risks. The scandal is that many risky behaviors remain insufficiently addressed.
To make finance safe—to prevent runs, credit crunches, and the need for government bailouts—the financial system must be made more resilient to disturbances that undermine the balance sheets of intermediaries. This means requiring greater capital and liquidity buffers, treating the activities of financial intermediaries alike regardless of who is performing them (whether it is a bank, a money market fund, or some other type of “shadow bank”) and modernizing the financial plumbing (including short-term financing mechanisms, collateral rules, and derivatives trading). These changes, combined with a streamlining of the U.S. regulatory apparatus itself, will reduce the incentives to take risks that trigger crises and bailouts, while making the system capable of absorbing the potentially large and unforeseen shocks that will inevitably come. Unfortunately, regulators face powerful opposition from politically connected financial intermediaries and their clients, all of whom benefit from high leverage and implicit, taxpayer-financed, government support. Viewed from this perspective, the focus on Glass-Steagall is a damaging distraction from the job of designing and implementing effective reforms that truly make our financial system safe.
John Berlau, a senior fellow at the Competitive Enterprise Institute
Election years are a time when politicians put on their favorite pair of rose-colored glasses and make future plans with an idealized view of the past. This year, that shiny object for many in both parties is Glass-Steagall. Glass-Steagall is touted as being of progressive origins, reining in big Wall Street banks, and bringing stability to the financial sector. But none of these claims square with reality.
First, the law’s sponsors, Senators Carter Glass of Virginia and Henry Steagall of Alabama, were not progressives but “Dixiecrats” who championed the “Jim Crow” segregated American South. Glass helped design Virginia’s poll tax and literacy test for the express purpose, in his own words, of ensuring “the complete supremacy of the white race in the affairs of government.” Glass’s horrific views on race don’t translate into him being automatically wrong on everything else, but they do at least warrant much more skepticism of his other ideas on public policy.
Second, since Glass-Steagall forbade “Main Street” commercial banks from venturing into investment banking, it actually protected Wall Street investment banks such as Bear Stearns and Goldman Sachs from competition, enabling them to get bigger. Through the 1980s, the Securities Industry Association, a trade group for investment banks, lobbied and litigated against any loosening of the law. And in the end, it was pure investment banks such as Bear and Lehman Brothers—neither of which had merged with commercial banks—that were the first dominoes to fall in the financial crisis.
To really curb the problem of “systemic risk”—or banks that are “too big to fail”—we must bring to the financial sector what virtually every other field of American business possesses: competition. Companies such as Borders and Blockbuster once dominated their industries but their implosions—while difficult for employees and stockholders—didn’t trigger a crisis. This is largely because competitors were standing ready to absorb demand from their customers.
But in the financial industry, policy makers have mistakenly thought an answer to ensuring stability is to limit competition. Since 2010, federal regulators have approved only two new banks to operate in the U.S. Before then, even in the depths of the savings-and-loan crisis, more than 100 new banks per year would get the green light from regulators to open.
Also, unlike virtually every other industrialized nation, the U.S. effectively bans non-financial corporations from owning bank affiliates. During the George W. Bush administration, some of the best-run American corporations—including Walmart, Home Depot, and Warren Buffett’s Berkshire Hathaway—tried and failed to get regulatory approval to create banking units. By contrast, in the United Kingdom, one out of eight pounds [units of currency] are taken from the cash machines of Tesco Bank, a division of the retail giant Tesco. And Canada and Mexico have allowed Walmart to operate the very banking units there that were denied to them by regulators here.
Financial stability can also be bolstered by creating special bankruptcy laws for the financial sector and limiting taxpayer-backed deposit insurance for the wealthiest savers, but allowing more competition must be at the forefront of any true financial reform.
Sheila Bair, president of Washington College and former Chairperson of the Federal Deposit Insurance Corporation (FDIC) under President George W. Bush
Repeal of Glass-Steagall, by itself, did not cause the crisis but it did exacerbate it. Glass-Steagall repeal was part of a broader movement in the late 1990s and early 2000s toward the idea of “self-correcting” markets—that banks knew better than regulators how to manage risk and regulate themselves. Even more damaging than Gramm-Leach-Bliley was the Commodity Futures Modernization Act which essentially made derivatives markets out of bounds for any regulatory authority—including the U.S. Commodity Futures Trading Commission and state insurance regulators. New “risk-based” capital standards, which provided highly generous capital treatment for mortgage-backed securities, derivatives contracts, and other risky assets, encouraged mega-banks to take on excessive levels of leverage and load up on assets which were in fact, high-risk. As a result, investment banks, in particular, had little cushion to absorb losses when the housing market turned and mortgage losses mounted. And those hundreds of billions of losses on the underlying mortgages translated into trillions of losses on derivatives contracts.
It is important to understand that not all supporters of reinstating Glass-Steagall are financial reformers. There is some (quiet) Wall Street support as well. I think their hope is that by forcing investment banks to separate from commercial banking, the investment banks would once again be free of prudential oversight by the Fed.
To be sure, Glass-Steagall repeal gave birth to larger, more complex institutions which were “too big to fail” given the regulatory tools available during the crisis. So, even if repeal did not drive the crisis, it certainly contributed to the need for bailouts of these behemoths. Another negative outcome of Glass-Steagall repeal, which is frequently overlooked, is the increase of political and market power by the mega-banks. There is too-big-to-fail and then there is simply too big. Politicians, media, think tanks—all are influenced in one way or the other by these powerful financial institutions. And given their tremendous market influence, even large corporations can be fearful about taking them on. Pre-Gramm-Leach-Bliley, the commercial banks and investment banks were frequently fighting with each other and offsetting each other’s agendas in Congress. You no longer have that dynamic.
I’m supportive of reinstating Glass-Steagall—particularly if it separates derivatives dealing from commercial banking. I don’t think that is an activity that should be included in the safety net and backed by things like FDIC insurance. But even more important is a dramatic strengthening of capital requirements for large banks, using a “leverage ratio,” not a risk-based capital standard. Risk-based rules do not work—they are static when risks are dynamic, subject to political influence and gaming by banks through their risk models. A 10 percent minimum leverage ratio—meaning that a mega-bank would have to fund itself with at least 10 percent equity and no more than 90 percent debt—would be the most effective thing we could do to stabilize our financial system and make sure that it is resilient during times of economic stress.
Helen Garten, a former law professor at Rutgers University
The rise of populism in both political parties and lingering anti-bank sentiment after the recession have fueled the movement to reinstate Glass-Steagall. Nostalgia is a factor as well. There is a perception that, back in the day of Glass-Steagall (the 1930s through the 1990s), financial institutions were simpler and safer, protecting us from financial crises. This perception is inaccurate, unfortunately. First, the wall between investment banking and commercial banking constructed by Glass-Steagall was crumbling as early as the 1960s as a result of industry innovation and regulatory encouragement. By the time Glass-Steagall was finally repealed in the late 1990s, banks were already in the securities business. Second, Glass-Steagall would not have prevented the financial crisis of 2008. Lehman and AIG were not part of diversified bank holding companies. Excessive risk taking by banks occurred in mortgage lending and securitization, both permitted under Glass-Steagall. Finally, although the end of Glass-Steagall did facilitate some mergers between large banks and securities firms, consolidation in the banking industry and the resulting "too big to fail" problem was a serious regulatory concern long before the statute's repeal.
It's impossible to go back to 1933. The complexity and interconnectivity of our financial markets are a reality, and managing risk requires a more nuanced approach than simply restoring Glass-Steagall. Some new techniques are already in place, including enhanced capital and liquidity requirements. The challenge for regulation is to find ways to improve banks' internal controls. One approach is to encourage large banks to simplify their complex and interconnected legal and business structures, which will facilitate regulatory oversight and enable more efficient resolution in the event of a failure of one or more units. Ironically, the result of simplification may be greater separation of different financial businesses within diversified banks, an internalized twist on the original Glass-Steagall model.
Alex Tabarrok, the director of the Center for Study of Public Choice and the Bartley J. Madden Chair in Economics at the Mercatus Center at George Mason University
When Black Lives Matter calls for a restoration of the Glass-Steagall Act we know that the Act has exited the realm of policy and entered that of mythology. No, restoring the Glass-Steagall Act would not end racism. Nor would restoring Glass-Steagall have done much, if anything, to have avoided the 2008-2009 financial crisis. Secretary of the Treasury Timothy Geithner was correct when he said the problems at the heart of the financial crisis had “nothing to do with Glass-Steagall.”
The financial crisis is best understood as a run on the shadow banking system, that collection of financial intermediaries who based their credit creation not on deposits but on repo, money market funds, structured investment vehicles, asset-backed securitizations and other financial structures. Separate commercial and investment banking? Please. The problem was that by 2007 the shadow banking system had become so separated from commercial banking that the Federal Reserve didn’t know that a majority of credit was being generated by the shadow banks. When the crisis came, moreover, the Federal Reserve was not prepared with the right tools to deal with the problem. Ironically, one of the few tools that did work was, thanks to the repeal of Glass-Steagall, the ability to merge investment and commercial banks which was crucial in arranging acquisition of Bear Stearns by JP Morgan and of Merrill Lynch by Bank of America.
Glass-Steagall Act was not even a good policy in dealing with the Great Depression. Eugene White [a professor of economics at Rutgers], for example, found that national banks with security affiliates were much less likely to fail than banks without affiliates. Randall Kroszner [a professor at University of Chicago and a former governor of the federal reserve system] and Raghuram Rajan [the governor of the Reserve Bank of India] found that securities issued by unified banks were (ex-post) of higher quality that those issued by investment banks. A powerful book by George Benston [who was a professor at Emory University] went through the entire Pecora hearings which supposedly revealed the problems with unified banking and found them to be a complete sham. Carlos Ramirez [a professor at George Mason University] showed that the separation of commercial and investment banking increased the cost of external finance. My own work unearthed the actual reasons for the separation in a titanic battle between the banking interests of the Morgans and Rockefellers, a real inside job.
“Nothing has been done!” may play well in some quarters but the Obama administration has in fact imposed systematic reform on the financial system. Most importantly, capital requirements have been increased (leverage has been reduced), forcing financial intermediaries to have greater skin in the game and to provide a cushion in the event of a fall in asset prices. Moreover, capital requirements have been extended far into the shadow banking system. Most recently, the Fed has imposed a capital surcharge on the biggest institutions i.e. the too big to fail institutions. As Fed Chair Janet Yellen said at the time the capital surcharge on the big players "will confront these firms with a choice: they must either hold substantially more capital, reducing the likelihood that they will fail, or else they must shrink their systemic footprint, reducing the harm that their failure would do to our financial system. Either outcome would enhance financial stability."
Ironically, despite the political power of the financial sector it seems that more has been done to raise bank capital ratios than to require homeowners to raise their capital ratios by requiring larger down payments. There is a lesson there.
Will these new rules prevent a future crisis? Of course not. No rules will prevent all manias, panics, and crashes but the new rules have reduced the likelihood of a large financial crisis and they have made smaller crises easier to manage.
Since no rules will prevent all crises it’s important that the Federal Reserve and the Federal government have room to make credible commitments in the event of a future crisis and that means keeping public debt low. We need an unbalanced budget amendment, a requirement to pay down debt and even run surpluses in good times so that capacity is at the ready in bad times. The fact that we do not yet have our budget fully under control is perhaps the biggest danger moving forward.
Lawrence White, professor of economics at New York University’s Stern School of Business
The idea of reviving Glass-Steagall is receiving more attention because it seems like a "simple"—and simple to describe—action that would separate investment banking from commercial banking and thereby reduce the size of the largest banks in the U.S. Unfortunately, since the removal of the Glass-Steagall restrictions in 1999 had no connection to the financial crisis of 2008—all of the "bad actors" of the 2008 crisis could have done all of the same things even if Glass-Steagall had been in place—the whole notion of a revival of Glass-Steagall is misguided.
A policy for curbing systemic risk would not involve a revival of Glass-Steagall, but does involve rigorous prudential regulation that has a number essential components: first, high capital requirements (relative to risks) for depositories and other financial institutions that have significant systemic connectivity with the overall financial system; substantial liquidity requirements for financial institutions that issue run-able short-term debt; activities limitations for prudentially regulated entities (limited to activities that are "examinable and supervisable"); managerial competency requirements for prudentially regulated entities; large numbers of well-trained and well-paid examiners and supervisors; and lastly, powers of receivership for the regulator.
Jeremy Venook and Nicholas Clairmont contributed reporting to this story.