While the Dodd-Frank Act aspired to making bold financial reform, the outcome of the 2010 reform law has proved to be rather middling. Dodd-Frank sought to end "too big to fail," but the biggest banks have only gotten bigger. And bank lobbying has helped to dilute many of the law's key provisions as regulators write rules to implement them.
For these and other reasons, the Glass-Steagall Act, which required federally backstopped commercial banks to focus on traditional banking activities like making loans and taking deposits, is due for a much-needed comeback. But before you cast aside Glass-Steagall as hoary, outdated and ineffective for dealing with a modern financial services sector — as industry proponents often do — consider how banks have not even begun to weigh the clear and obvious benefits to their industry of restoring the Depression-era law.
They say everything old is new again. Despite the repeal of the law over 15 years ago, a modern version of Glass-Steagall still has its champions on Capitol Hill, in both parties. The proposed 21st Century Glass-Steagall Act — sponsored by Democratic Sen. Elizabeth Warren and Republican Sen. John McCain — mirrors many of the features of the original law, while also accounting for more recent innovations in banking and finance. The Glass-Steagall standard has also garnered support from several presidential candidates, both Democratic (Bernie Sanders and Martin O'Malley) and Republican (Mike Huckabee and Ben Carson).
The original 1933 law barred investment banks from accessing the Federal Reserve's discount window and federally insured deposits. The purpose was to limit the ability of financiers to engage in the kind of speculation that caused the worldwide market crash of 1929. As Warren has observed, the U.S. has suffered from a boom-and-bust cycle every 15 years, with the notable exception of the prosperous half-century during which Glass-Steagall was in effect.
Was it a mere coincidence that the repeal of Glass-Steagall at the turn of the century presaged the worst financial crisis since the Great Depression? We can leave that historical question to economists and other polemicists. The most important question now is: what steps can the nation take to avoid the next financial catastrophe?
Dodd-Frank has proven not up to the challenge. Any honest observer would admit that the "too big to fail" problem persists. Bank size has actually increased since 2008, with the six biggest banks lording over a combined $10 trillion in assets. In comparison, the entire U.S. GDP is only $17 trillion.
And many of Dodd-Frank's provisions have been gutted both at the regulatory and legislative levels. For instance, the Volcker Rule was initially conceived by former Fed Chairman Paul Volcker as a three-page approximation of Glass-Steagall. But by the time the regulators adopted the final version of the rule, it was hundreds of pages long and riddled with loopholes, exceptions, exemptions and other legal gobbledygook. Similarly, bank-friendly legislators effectively repealed Dodd-Frank's swaps pushout rule — which would have greatly reduced banks' exposures to the most risky derivatives — by hijacking the congressional budget approval process at the eleventh hour in December 2014.
Proponents of a new Glass-Steagall law correctly point out that it would reduce speculation, hyper-liquidity and profiteering in banking, thereby benefiting the broader economy. But the re-imposition of that law would also benefit banks themselves.
First, a Glass-Steagall firewall would make banks safer by eliminating perverse incentives for profiteering. Under the firewall, commercial banks would be prohibited outright from speculative activity. And divested investment banking units would become more judicious about risking their — or their clients' — capital since those units would no longer have any recourse to trillions of dollars in Federal Reserve largess (or insured customer deposits).
Second, the Glass-Steagall standard would reduce costs for banks.
Dodd-Frank has adopted often-feckless half-measures that inordinately rely on the discretion of regulators. In contrast, Glass-Steagall would impose clear structural demarcations that reduce compliance costs. For example, the well-intentioned Volcker Rule requires bank compliance departments to spend billions making abstruse epistemological distinctions between market-making and proprietary trading. The Office of the Comptroller of the Currency has estimated that Volcker compliance costs will total $4.3 billion. A large chunk of those costs would be obviated under a strict Glass-Steagall standard that relied on simple corporate separation.
Under Glass-Steagall, large banks could also avoid having to meet costly capital requirements, which are higher for TBTF institutions. Under "total loss absorbing capacity" rules, the biggest global banks will be required to maintain capital and long-term debt of over 16% of risk-weighted assets. Similarly, commercial banks would avoid higher capital charges applicable for nontraditional banking activities like insurance.
By reducing bank size, Glass-Steagall would also help erode the stultifying oligopoly that is currently endemic to the banking industry. Community banks would benefit because they would be able to better compete on a level playing field with behemoths like Citigroup and JPMorgan Chase. Main Street businesses would also benefit from such a shift. Community banks are more likely than large banks to directly lend to job-creating small businesses.
To be fair, Glass-Steagall is no panacea. It would not stop the flow of risk-taking from well-regulated banks to loosely regulated shadow banks. Further regulation and oversight is sorely needed to address those problems. But the restoration of the law would go a long way toward addressing TBTF — a vexing problem that Dodd-Frank has not addressed.
Akshat Tewary is an attorney practicing in New Jersey, a Financial Industry Regulatory Authority arbitrator and President of Occupy the SEC, a nonprofit advocating for financial reform. His Twitter handle is @akshattewary.