Economics 101: What is Glass Steagall??
The
Glass-Steagall Act was enacted during the Great Depression. It protected bank
depositors from the additional risks associated with security transactions. The
act was dismantled in 1999. Consequently, the distinction between commercial
banks and brokerage firms has blurred; many banks own brokerage firms and
provide investment services.
R
‘Shatterer of Glass-Steagall’ calls for
its restoration
The former boss of giant U.S. bank Citigroup, Sanford (Sandy) Weill, who
possesses a giant wooden plaque listing his accomplishments which includes the
line, “The Shatterer of Glass-Steagall”, has shocked the banking world by
calling for its restoration.
Weill is falling in with the global push to restore
Glass-Steagall long associated with U.S.
physical economist Lyndon LaRouche, which some of the leading bankers in Britain recently boosted following the
revelations of 16 London
banks flagrantly manipulating the benchmark London Interbank Offered Rate to
rip off the world.
But it is Weill’s call that has shocked Wall Street,
because he was the key lobbyist for the repeal of
Glass-Steagall. In 1998 Greenspan granted a waiver to Travelers
Insurance Company, then headed by Sanford Weill, to buy Citibank. Travelers
owned Salomon Smith Barney, a large investment bank. The Travelers-Citibank
merger, for the first time since the passage of Glass-Steagall in 1933, allowed
a single bank holding company to own a commercial bank, an insurance company,
and an investment bank. This waiver spelt the beginning of the end of
Glass-Steagall [repealed a year later through the Gramm-Leach-Bliley Act, which
Congressmen variously dubbed the Citi-Travellers Bill, or Sandy’s Bill], and
the birth of institutions that are “too big to fail”.
“In the space of a few seconds, Sanford Weill disavowed
the work of a lifetime,” reported the July 27 The
Australian. “Mr Weill, who built up Citigroup into a banking behemoth …
yesterday called for the break-up of the big banks,” the article continued.
“The stunning suggestion from the man who created
Citigroup from the 1998 merger of Travelers and Citibank lit a bonfire under a
simmering ‘too big to fail’ debate”, continued the Australian Financial Review of the same day. “The Citigroup merger
required a waiver of the Glass-Steagall
Act—which had prohibited such combinations since 1933—until the law could
be repealed a year later, in 1999,” the Review revealed.
On July 25 American Banker Magazine reported that both Democratic and
Republican congressmen were thunderstruck by Sandy Weill's comments,
“suggesting a new openness to the argument that the nation’s largest banks
should be broken up.” “It is absolutely huge that Sandy Weill has called for
the break-up of the big banks,” one Democratic Representative was quoted
saying.
The magazine was brave enough to acknowledge the
heretofore lone voice of Lyndon LaRouche on the issue: “Supporters of Lyndon
LaRouche have recently been distributing pamphlets outside the Capitol calling
for the return of Glass-Steagall—a symbol of how politically marginal the
debate about breaking up the big banks has been until now. …” [emphasis added]
In a video interview, the magazine’s editor-in-chief observed, “One of the
things that was really interesting about it was that it seemed that this was
the moment that actually the breakup the big banks movement started to get some
traction, at least in the popular press, maybe in Washington.”
The July 26 New
York Times editorial did
their own Olympic-quality backflip on Glass-Steagall, following Weill’s,
declaring, “While we are on this subject, add The
New York Times editorial page
to the list of the converted. We forcefully advocated the repeal of the Glass-Steagall Act. … Having
seen the results of this sweeping deregulation, we now think we were wrong to
have supported it.”
The Glass-Steagall debate has also broken into popular
entertainment, featuring in an episode of the new U.S. docudrama Newsroom, in which a character
offers the following excellent explanation of Glass-Steagall: “Congress wanted
to put a firewall in between the investment banks and the commercial banks.
They wanted to make sure that Wall Street could melt to the ground, and the
commercial banks wouldn’t be touched. They passed a law, the Glass-Steagall Act: Now, you
could be Gordon Gekko [tycoon from movie ‘Wall Street’] or George Bailey
[community banker from ‘It’s a Wonderful Life’], but you couldn’t be both.”
[Emphasis added]
LaRouche affirmed that what began a few weeks ago in Britain, has now exploded onto the front burner
in the United States.
“These are people who have chosen the future,” he said. “They have changed
their direction of commitment, to support Glass-Steagall, when they had been,
up to that point, exactly in the opposite direction.”
The restoration of Glass-Steagall is the centerpiece of
the CEC’s resolution, The
Future of Australia: Develop or Die.As the CEC exposed last week,
the corruption of the financial system on display in the manipulation of the
LIBOR reaches deep into Australia,
through the direct impact of the LIBOR itself and the possible manipulation of Australia’s
LIBOR-equivalent, the BBSW. This flagrant corruption goes hand in hand with the
deregulation of the economy kick-started in 1983 by Hawke and Keating and
continued by their Liberal accomplices. Only implementing the Glass-Steagall
principle can reverse the policies that opened up the financial affairs of
ordinary Australians and essential government services to undisguised looting
by the global banking cartel.
The
banks that were at the forefront of the crisis – Bear Stearns, Lehman Brothers,
Washington Mutual, Countrywide – were either pure investment banks or pure
commercial banks. The ability to merge the two types was crucial in mounting
swift rescues to stabilise the system – such as the acquisition of Bear Stearns by JP
Morgan and of Merrill
Lynch by Bank of America.
............................................................................
Why I was won over by Glass Stegall….
By Luigi Zingales
There are
certainly better ways to deal with excessive risk-taking behaviour by banks,
but we must not allow the perfect to become the enemy of the good. In the
absence of these better mechanisms, it makes perfect economic sense to restrict
commercial banks’ investments in very risky activities, because their deposits
are insured. Short of removing that insurance – and I doubt commercial banks
are ready for that – restricting the set of activities they undertake is the
simplest way to cope with the burden that banks can impose on taxpayers.
The Volcker rule, which prohibits banks
from engaging in proprietary trading but allows them to put their principal at
risk, is not a good substitute. Proprietary trading is when a bank invests in
stock hoping that its price will go up. A bank engages in principal trading
when it buys a stock from a client as a service to that client, who wants to
unload his position quickly. The difference is therefore one only of
intentions, which are impossible to detect, since any transaction involves two
consenting parties.
The second reason why Glass- Steagall won
me over was its simplicity. The Glass-Steagall Act was just 37 pages long. The
so-called Volcker rule has been transformed into 298 pages of mumbo jumbo,
which will require armies of lawyers to interpret. The simpler a rule is, the
fewer provisions there are and the less it costs to enforce them. The simpler
it is, the easier it is for voters to understand and voice their opinions
accordingly. Finally, the simpler it is, the more difficult it is for someone
with vested interests to get away with distorting some obscure facet.
The third reason why I came to support
Glass-Steagall was because I realised it was not simply a coincidence that we
witnessed a prospering of securities markets and the blossoming of new ones
(options and futures markets) while Glass-Steagall was in place, but since its
repeal have seen a demise of public equity markets and an explosion of opaque
over-the-counter ones.
To function properly markets need a large
number of independent traders. The separation between commercial and investment
banking deprived investment banks of access to cheap funds (in the form of
deposits), forcing them to limit their size and the size of their bets. These
limitations increased the number of market participants, making markets more
liquid. With the repeal of Glass-Steagall, investment banks exploded in size
and so did their market power. As a result, the new financial instruments (such
as credit default swaps) developed in an opaque over-the-counter
market populated by a few powerful dealers, rather than in a well regulated and
transparent public market.
The separation between investment and
commercial banking also helps make the financial system more resilient. After
the 1987 stock market crash, the economy was unaffected because commercial
banks were untouched by plummeting equity prices. During the 1990-91 banking
crisis, securities markets helped alleviate the credit crunch because they were
unaffected by the banking crisis. By contrast, in 2008 the banking crisis and
the stock market crisis infected each other, pulling down the entire economy.
Last but not least, Glass-Steagall helped
restrain the political power of banks. Under the old regime, commercial banks,
investment banks and insurance companies had different agendas, so their
lobbying efforts tended to offset one another. But after the restrictions
ended, the interests of all the major players were aligned. This gave the
industry disproportionate power in shaping the political agenda. This excessive
power has damaged not only the economy but the financial sector itself. One way
to combat this excessive power, if only partially, is to bring Glass-Steagall
back.
The writer is a professor at the University of Chicago Booth School of Business and
author of ‘A Capitalism for the People: Recapturing the Lost Genius of American
Prosperity’, published this week
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