Legal Commentary

The Alleged Virtues Of Glass-Steagall

By Big Tent Democrat

I saw this Confluence post linked at Booman (the point appears to be that Riverdaughter dakinkat is being like Jane Hamsher (and her alliance with Grover Norquist) by praising the Cantwell/McCain proposal to reinstate Glass-Steagall, though, to be honest, I am not sure what Booman's point is). It argues in favor of a proposal to reinstate Glass-Steagall. It cites this Bloomberg report:

A one-page proposal gaining traction in Congress could turn back the clock on Wall Street 10 years, forcing the breakup of banks, including Citigroup Inc. Lawmakers in both parties, seeking to prevent future financial crises while soothing public anger over bailouts and bonuses, are turning to an approach that’s both simple and transformative: re-imposing sections of the 1933 Glass-Steagall Act that separated commercial and investment banking.

Of course this sounds good to populists (and is probably good politics), but is it good policy? I addressed this issue a bit last year. The financial meltdown was not caused by the repeal of Glass-Steagall. More . . .

From the Bloomberg article:

Resurrecting Glass-Steagall goes beyond the array of new regulatory powers that President Barack Obama has proposed to fix the financial system. It has also sparked debate among academics, regulators and legislators over whether the Depression-era law could have prevented the crisis of 2008 or might help avoid future ones.

‘No Difference’ -- “If you look at what happened, with or without Glass- Steagall, it would have made no difference,” said H. Rodgin Cohen, chairman of New York-based law firm Sullivan & Cromwell LLP, who represented one side or the other in more than a dozen transactions stemming from the financial crisis last year, including the rescues of Bear Stearns Cos., Fannie Mae, Wachovia Corp., and American International Group Inc.

Cohen and others say the law wouldn’t have saved Bear Stearns or Lehman Brothers Holdings Inc., both of which were pure investment banks, from collapse. And the government would not have been able to enlist JPMorgan Chase & Co. to take on the assets of Bear Stearns or allow Goldman Sachs Group Inc. and Morgan Stanley to become bank holding companies, giving them access to the Federal Reserve’s discount window.

Rather than split up banks, regulators should provide better supervision and require tougher capital requirements, said Cohen, who was also involved on behalf of banking clients in shaping the bill that dismantled parts of Glass-Steagall.

I'll go further. The problem with the government's response to the financial crisis has been its unwillingness to apply the existing regulatory model to it. I speak specifically of Citibank and BoA, two insolvent banks that should be in federal receivership. Reenacting Glass-Steagall will mean nothing to the problem of regulatory capture. Consider the argument in favor of Glass-Steagall:

“What we need is a 21st century Glass-Steagall,” said Gerald Rosenfeld, deputy chairman of Rothschild North America Inc. and a professor of business and law at New York University. Rosenfeld favors regulating commercial banks like public utilities, while giving securities firms and hedge funds more freedom, as long as they adhere to capital guidelines. “The important thing is we have to have a structure that prevents the contagion from spreading when there are catastrophic losses in those riskier businesses,” he said.

In my view, this is a ridiculous analysis. This would allow the same endemic risk to build up, even if it isolates the risk from commercial banks. The idea of prohibiting proprietary trading by commercial AND investment banks makes more sense:

To prevent a domino effect, systemically important financial institutions shouldn’t be allowed to engage in proprietary trading that involved “particularly high risks” or “serious conflicts of interest,” the group said.

That is a proposal I heartily support. Let wealthy investors gamble with their own money. But institutional players, so dependent on government support and, sometimes, largesse, are indeed akin to public utilities. They simply can not be allowed to play in the casino.

Speaking for me only

Full post as published by TalkLeft on December 30, 2009 (boomark / email).