A bipartisan group of senators has reintroduced legislation to establish a modern Glass-Steagall framework. It is unclear whether the bill will gain any traction, especially in an environment that favors deregulation, not a return to more restrictive limits.

What is more puzzling is how, based on my data, a 21st-century version of the Depression-era limitations on bank activities will do little to meet the goals laid out by its proponents.

The 21st Century Glass-Steagall Act of 2017 — a bill sponsored by Sens. Elizabeth Warren, D-Mass., John McCain, R-Ariz., Maria Cantwell, D-Wash., and Angus King, I-Maine — would require federally insured institutions to primarily take deposits and make consumer and commercial loans. The bill attempts to stop taxpayer bailouts by segregating deposit-taking institutions from financial institutions engaged in higher-risk financial activities.

But if the law were to pass, after required divestitures today’s largest financial institutions would still be “too big to fail,” and the two largest investment banks would likely increase their systemic importance.

Under the legislation, deposit-taking institutions would be prohibited from (or being affiliated with any firms providing) investment banking, broker-dealer services, swaps dealing, futures dealing, hedge fund ownership, prime brokerage services, and issuing or investing in structured financial products. Bank holding companies would be forced to divest ownership in affiliates engaging in prohibited activities and required to sell prohibited investments and relinquish nonapproved derivative positions.

To get an idea of the financial landscape under the Glass-Steagall Act of 2017, I estimated the potential impact of the law on the 10 largest U.S. bank holding companies using data from December bank holding company reports. I measured the law’s impact in two ways. First, I analyzed its likely effect on holding company balance sheets by assuming that holding companies divest prohibited assets. In a second approach, I estimated the share of holding company revenues that accrue from prohibited activities.

Company Assets prohibited by Glass-Steagall Revenue prohibited by Glass-Steagall
JPMorgan Chase 30.4% 23.4%
Bank of America 21.7% 25.8%
Wells Fargo 11.6% 17.7%
Citigroup 28.7% 19.9%
Goldman Sachs 12.3% 69.9%
Morgan Stanley 19.0% 75.1%
U.S. Bancorp 1.1% 4.2%
PNC Financial Services 5.6% 13.2%
Capital One 2.2% 0.5%
TD Group U.S. Holdings 21.2% 1.6%

I assumed that institutions that are primarily commercial banks will remain so by divesting all assets and affiliate positions prohibited under the Glass-Steagall legislation. For the bank holding companies that are primarily investment banks — Goldman Sachs and Morgan Stanley — I assumed that they divest their commercial bank deposits and associated assets.

Based on estimates of required asset divestitures, the bill would have a large impact on four institutions: JPMorgan Chase, Citigroup, Bank of America and TD Group. It would have a relatively minor impact on the two investment banks because the commercial banking activities they are assumed to divest are not a major component of their activities.

From an income perspective, the four largest bank holding companies would face important reductions in revenue if they eliminated prohibited activities. Bank of America faces the largest forced reduction (25.8%). For the two investment banks, the prohibited share of revenues reported in the table are actually the revenues they would retain if they reacted by selling their deposit taking activities and focusing on investment banking.

After required divestitures, the top 10 systemically important financial institutions would still comprise the largest nine U.S. SIFIs. Only TD Group is at risk of being replaced on the top-10 list, by Bank of New York Mellon. Both approaches suggest that, under the Glass-Steagall Act of 2017, the 10 largest SIFIs would all remain “too big to fail.” Indeed, some SIFIs — Goldman Sachs and Morgan Stanley in particular — would likely increase in systemic importance.

Before the financial crisis, there were five large domestic investment banks. Today there are two. When JPMorgan Chase, Bank of America and Citigroup divest investment banking operations, chances are good that Goldman Sachs and Morgan Stanley will be eager bidders. While unintended, the new legislation would almost certainly increase concentration in investment banking services. This would leave the government little maneuvering room to allow Goldman Sachs or Morgan Stanley to fail should they suffer future financial distress.

The Glass-Steagall Act of 2017 is based on the mistaken belief that liberal access to government-insured deposit funding caused the financial crisis. Of the firms whose failure precipitated the financial crisis — Bear Sterns, Freddie Mac, Fannie Mae, Lehman Brothers and AIG — none were banks. Of these institutions, Lehman Brothers owned a subsidiary bank, and AIG owned a small thrift, neither of which failed in the crisis. It’s hard to see how separating commercial and investment banking would have prevented the failure of their parent firms.

In all likelihood, the Glass-Steagall Act of 2017 would just redistribute assets and activities among the existing “too big to fail” institutions. Like rearranging deck chairs on the Titanic, this change is unlikely to address the underlying problem.

The real “too big to fail” problem is not caused by FDIC deposit insurance, but from the implicit belief among investors that the government will protect all creditors of large important failing financial institutions, not just insured depositors — especially if multiple important financial institution are failing simultaneously. Unlike FDIC deposit insurance, financial institutions never pay a dime for this kind of insurance, but this implicit government guarantee is the true source of the “too big to fail” problem. The Glass-Steagall Act of 2017 does nothing to fix the implicit government guarantee problem — and indeed it would probably make it worse.

Paul H. Kupiec

Paul H. Kupiec

Paul H. Kupiec is a resident scholar at the American Enterprise Institute.

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