Friday, December 25, 2009

Did the repeal of Glass Steagall create big banks and lead to the financial crisis?

Glass Steagall

One thing to remember about the last 10 years of consolidation is that 10 years make a nice memory, but actually most of the 70 years under Glass-Steagall were all a period of consolidation. Consolidation didn’t result from a single act; it pre dates the repeal of Glass Steagall. The first big spurt of consolidation came during the depression when so many small banks failed -- another came in the 60’s, then the 70’s, another in the 80’s, and so on. It’s been so steady it’s silly to try to attribute it to any one event. Also, under Glass Steagall we weren’t free from banking problems (Continental Illinois and the S&L collapse spring to mind).

Many countries with only a few big banks faired much better than the US during the depression, especially in terms of banking problems. They also got along quite fine without Glass Steagall during the 70 years we operated under Glass Steagall. Further, both the current crisis and the depression were global -- hardly related to the banking structure in any one country.

Glass Steagall-type regs are a Red Herring. I say that despite a natural disposition in favor of Glass Steagall. (I grew up with it after all. It's like a childhood friend). But, the current problems didn't originate in banks. They were the result of excesses in the shadow banking system and among consumers. And, in terms of institutions, they were aggravated by organizations that weren't at all related to changes in Glass Steagall.

It would be strange, indeed, if the regs that were appropriate in the mid 20th century turned out to be appropriate in the 21st. Remembrances of an idealized “days gone by” are easy. The hard part is figuring out what makes sense now.

Some legislation will pass; it’s too easy to vilify banks (i.e, think Potter in the movie “It’s a Wonderful Life”). But remember George Bailey was a banker, too. If you want to split hairs and differentiate between a thrift (Bailey Building and Loan) and a bank, it would be more defensible to target thrifts as the culprits (Golden West, WAMU, IndiMac). But, depository institutions didn’t cause this mess even if the politicians find them convenient to blame.

If something like Glass Steagall passes and gets signed, the logical reaction is ambivalence. If it makes people feel safer, that’s good. If it really make them less safe, that’s bad. But, they will only feel safe until a WAMU, Bear Sterns, Lehman Brothers, Merrill Lynch, AIG, Fannie or Freddie blows up.