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Stop Romanticizing Glass-Steagall

Not even Sandy Weill could answer the question: What economic or financial problem would be solved by a return to the Depression-era Glass-Steagall Act? Perhaps he is not expected to. His TV interlocutors did not really press him on the point, leaving him vaguely to suggest it might help banks with their public relations issues. Maybe it would or maybe it wouldn't, but financial policy should transcend concern about banking industry PR.

Financial policy should not transcend involvement in the tough, very detailed work of crafting a practical bank supervision program that fits the American economy, still by far the largest and most diversified economy in the world, thanks in no small part to having the best and most diversified financial system in the world. The modern, neo-Glass-Steagall advocacy has a mystical quality about it, an appeal that proposes to rise above the tough debate over the thorny details and reach back to a mythical time when bank regulation worked so very well, equated in an ineffable way with the Glass-Steagall Act. The appeal is to be taken on faith; the only questions allowed being a tired catechism with each answer being "break up the big banks."It is hard to get its advocates past their ecstasy and focused on details such as cause and effect and how Glass-Steagall would help America's banking customers.

Last year at a symposium held by the Federal Reserve Bank of Chicago, I presented a list of some two-dozen types of banks in contemporary America, differentiated by charter, business model, size, geography and other factors. My point was that behind each of these banks is a group of customers who believe their bank is the best choice for their financial needs. The goal of a regulatory system with the purpose of serving customers should be to support that variety, not dislocate customers. That was a dynamic list, by the way, constantly changing as customer needs and preferences change.

Wrestling with and addressing the issues of how best to serve American customers in an evolving economy are exactly what produced the Gramm-Leach-Bliley Act of 1999 (GLBA). There was and is no religious attachment to the 1999 law, as no one then or since claimed that GLBA was perfect, and most predicted it would need revision as the economy continued to evolve. It was, however, the product of decades of review and real-world experience with the weaknesses of the Glass-Steagall Act. The careful work grounded in the reality of the American economy explains the bipartisan (or non-partisan) result, uniting arguably the most conservative member of the Senate, Phil Gramm of Texas and perhaps the Senate's most liberal member, Paul Sarbanes of Maryland, who were joined by 88 more of their colleagues to pass the law. It was supported by all of the federal financial regulators and strongly advocated by the Clinton Administration. 

Rather than impugn that work, the experience of the recent recession has reaffirmed its wisdom. Because of the 1999 legislation, there were well-diversified firms ready in 2008 and 2009 to pick up the pieces of the much less diversified (and Glass-Steagall modeled) firms Bear Stearns, Lehman Brothers, Merrill Lynch and even Washington Mutual and Wachovia Bank. None of those failing firms was too big to fail, in part because there were financially stronger firms available to ensure the essential services of those failed firms would continue to be provided to their customers.

There are important lessons to be learned and reforms to be applied from our recent financial trauma. Reaching back into the midst of the Depression would hardly seem to be an auspicious place to look for answers that will work. The Dodd-Frank Act was a partisan effort at reform. It surely is not working as well as advocates had hoped. While implementation drags on, the financial system remains in regulatory crisis and the economy languishes. A more bipartisan effort focused on providing the best answers to serve all of our nation's diverse financial customers is needed and hopefully will be taken up in earnest by the next Congress.

In the meantime, here is a question for those who would arbitrarily break up banks: What is the optimal size for a bank in America? The best answers break-up advocates offer are the findings of their own personal meditations, for conversion to national policy. What are the customers in the marketplace telling us about the optimal sized bank? Many.

Wayne A. Abernathy is executive vice president for financial institutions policy and regulatory affairs at the American Bankers Association. Previously he served as assistant secretary of the Treasury for financial institutions and was staff director of the Senate Banking Committee when Congress enacted the Gramm-Leach-Bliley Act.



(12) Comments



Comments (12)
Glass Steagall worked, Lehmann, BearSterns, Merrill Lynch all went down, as they should have for their unrestrained risk taking and enormous leverage. Now we have JP Morgan Chase. Who will monitor the separation of investment bank funds and commercial bank funds? JP Morgan Chase? Their London Whale demonstrated their vulnerability from within by one person. Keep commercial banks and investment banks separate and regulate investment banks. If they fail, they fail and the US tax payer can rest assured that there will be no bailout at their expense.
Posted by Tmcgraw | Wednesday, August 01 2012 at 10:57AM ET
No single entity should be large enough to bring down the financial system. This is a simple enough principle.

Mr. Abernathy's assertion that Bear, Lehman, WaMu and others were not Too Big to Fail is patently wrong, and I am sure he knows it. Bear was TBTF so it got bailed out with under 13(3)'s extreme and exigent clause, and Jamie got a steal (literally) at $2 (oops, I mean $10) a share.

The manner in which Lehman was handled, many would now agree, was a mistake and the FRB and the UST sent massive mixed signals to the market that exacerbated the problems. Recall the rightful accusation of picking winners and losers.

Further, Abernathy is wrong to assert that many of the organizations didn't receive exceptional assistance. One small example: Has anyone bothered to mention GE Capital and the obscene about of concentration in the CP market in September of 2008? 10% of the A1/P1 space. Why? Because they ride the curve to juice top tier's earnings. The ONLY REASON a "AAA" rated corporate didn't fail was thanks to the TLGP which, by the way, Chairman Bair wasn't fond of executing (rightfully so). It likely helped that Immelt was - like Dimon - on the Board of the NY FRB and is now the President's special advisor. Absent the swath of "innovative" (a more traditional view of 13(3) might opine - illegal structures and actions) structures and actions under the 13(3) clause, the system would've seen a raft of failures well beyond the names mentioned.

The "wild west" culture of many of the guilty, dead, and dying banks was converted from a "buy-and-hold" mentality to a "gain on sale" trading mentality: the "originate to distribute" model. How much of the securitization market was spurred by the actions of affiliated securities subs? Ask: Why is this market still moribund and what impact has this dead market had on credit availability, the velocity of money, and the on-going de-leveraging in the system?

The Markowitz Efficient portfolio simply didn't exist during the crisis and all banks - the TBTF/SIFI/G-SIFI banks - were humbled by their exposure and loss correlations. While Glass-Steagall wasn't perfect, it is a far cry better than Dodd-Frank, and Abernathy et al will - in time - be remembered for their rightful contributions, regardless of the marketing spin they want to attribute to the crisis. Like the Maestro who claimed in his book that his monetary policy didn't contribute to the global liquidity glut, Abernathy's errors will be made clear by the passage of time. Thankfully, we don't need to let time pass, we can judge his arguments empirically which, to a large extent, the Dallas FRB, the IMF, and other credible names have done this for us.

While size can be a red-herring, complexity is not. Opaque business models and firm size are positively related to complexity. The infrastructure of the G-SIFI/SIFIs is brittle, the data a disaster (proof: try asking for weekly or even monthly FR-Y14A and M schedules to be submitted), and the diversification spurious.

Combine the above facts with a rogue, wild-west mentality egged on by disturbing national housing policies and you get a broken system. A system in which the GSEs are owned by the USG yet are not consolidated in the budget, an accounting result that flies in the face of all private sector accounting rules.

In this state space, size does matter - just perhaps not relevant to Mr. Abernathy given his political agenda, historical contributions, and current agenda. If the TBTF banks are such a great idea, I have one for the author of the article to consider: Place your net worth in the TBTF names. Put your money where your mouth is. I am betting the conviction isn't that profound.
Posted by Stentor | Tuesday, July 31 2012 at 8:09PM ET
to gsutton,
I don't know the exact number, but there are roughly 230 community banks that failed throughout the country, received TARP and still have yet to pay it back. To my knowledge, I don't think they have Securities businesses.

I agree, the Fed performed magnificently during a time of great uncertainty.
Posted by RCBanker | Tuesday, July 31 2012 at 6:46PM ET
The S&L Crisis occurred when GS was in play. More to the point of GSutton, the evidence of who failed and who did not during the most recent crisis absolutely destroys the myth that we need to reinstate GS. I'm also fairly certain that the global financial crisis occurred because many mortgage lenders became irrational in the assumed risk of their portfolios which was pushed further by the Fed's willingness to insure them. The link between mortgage lending and Fannie & Freddie is a more clear explanation of the crisis than any other argument, yet we are focused on hurting our nation's largest banks because they chose the correct growth paths. The fact is, we need more universal banks, and the U.S. would benefit from a big wave of consolidation in the sector.
Posted by @Patrick_J_Sims | Tuesday, July 31 2012 at 6:44PM ET
To clarify the record, many bank holding companies and their subsidiary banks were backstopped by the Fed in terms of guaranteeing liquidity during the recent financial crisis. That is what the Fed was originally designed to do and it performed magnificently during the crisis.

Securities activities, both underwriting and prop trading were always separated within the big securities firms. Lehman, for example, had a subsidiary bank. It made traditional commercial loans to Lehman's clients. It operated as a separate entity and did not mix its assets with those of its affiliates. When Lehman collapsed, the bank completely separated from the parent operationally, shut down lending and commenced a controlled liquidation. After collecting or selling its loans, the bank repaid all of its creditors and depositors in full then paid a nearly $2 billion liquidating dividend to the parent's bankruptcy trustee.

The notion that Gramm-Leach-Bliley permitted a mixing of commercial and investment banking is simplistic and wrong. GLBA allows common ownership of distinct subsidiaries that engage in the different kinds of financial activities each with its own balance sheet and assets. The bank subsidiaries of Lehman, Goldman, Morgan Stanley and Merrill Lynch were all separate subsidiaries and none failed during the downturn or received or required assistance. The actual record of these banks provides no case for reinstating Glass-Steagall.

Those who argue that Glass Steagall should be reinstated because the nation prospered when it was in effect forget or didn't learn the post hoc fallacy. Because A happens and then B happens does not establish or show in any way that A caused B. Actual cause and effect must be shown. How many stand alone banks failed during that period?
Posted by gsutton | Tuesday, July 31 2012 at 5:46PM ET
The article mentions the "well-diversified firms ready... to pick up the pieces of the much less diversified (and Glass-Steagall modeled) firms". Those 'well diversified' firms were federally insured depository institutions that would have likely been bankrupt if the government had not stepped in. Call it Glass-Stegall, call it anything you want - what is clear is that we need to separate underwriting and prop trading from traditional banking.
Posted by @banklawguy | Tuesday, July 31 2012 at 5:12PM ET
My motto in tackling problems has always been to divide and conquer. The question is...Do investment banks have to include traditional banking? If not, divide and conquer, split them off so that regulators will have less complex issues to face. In other words...the KISS principal.

In trying to defend or attack any of the pieces of our financial regulation/policy and the organizations in charge, one needs to realize that everything was broken.
Posted by higgins23 | Tuesday, July 31 2012 at 5:01PM ET
My motto in tackling problems has always been to divide and conquer. The question is...Do investment banks have to include traditional banking? If not, divide and conquer, split them off so that regulators will have less complex issues to face. In other words...the KISS principal.

In trying to defend or attack any of the pieces of our financial regulation/policy and the organizations in charge, one needs to realize that everything was broken.
Posted by higgins23 | Tuesday, July 31 2012 at 5:01PM ET
I think today's Washington could use a little more of Occam's Razor - the simplist solution is most often the correct solution. The fact is that Glass-Steagall worked for 80 years. Is there any correlation between the fact that we did not have a major financial collapse on the scale of the Great Depression during the entire time that Glass-Steagall was in effect, and that just 7 years after it was repealed we had another Great Depression? The mother of all coincidences!
Posted by commobanker | Tuesday, July 31 2012 at 4:48PM ET
Glass-Steagall was a simple concept. If the Financial Markets melted down to a point like they did in The Great Depression, Banks would still be able to function. Credit would still flow to small businesses and consumers. The financial services impact would not affect Depository institutions because they aren't tied to the market as closely as it is now. Balance sheets & trading books would be as impactful. Glass-Steagall gave rise to 60 years of economic growth. It would be hard to go back, but it's worth a serious discussion.
Posted by RCBanker | Tuesday, July 31 2012 at 4:43PM ET
In the immortal words of President Ronald Reagan "Well, here we go again" More syllogistic fallaacies, more of the same old arguements. Since Wayne was Gramm's point man on, you know, Gramm-Leach-Bliley did anyone expect him to feel differently on this matter? I think not.
Posted by commobanker | Tuesday, July 31 2012 at 4:43PM ET
Simple solution, no on balance sheet/off balance sheet, no trading book vs banking book. All products have the same capital treatments, PDs LGDs and EADs. Minmum tenor of one year.
Posted by Old School Banker | Tuesday, July 31 2012 at 4:33PM ET
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