Forget Dodd-Frank: Reinstate Glass Steagall

I can only imagine what a stampede of bison must have sounded like in the early 1800s. I assume it started as a barely audible rumble… maybe nothing more than a faint vibration. One thing is clear though. It was a sound that no one on the plains wanted to hear.

Numbering in the millions, each animal weighed 900-2000 pounds. In a herd, their modest initial sound would slowly crescendo from that low rumble to the sound of a fleet of 747s taking off in unison. Any man, other animals, or infirm structures would eventually be crushed like ants. The same could be said of the gradual roll-back in safeguards, safety nets, or any other mechanism that was put in place after the most cataclysmic economic event of the 20th century…The Worldwide Great Depression of the 1930s.

The call for the return of the Glass-Steagall Act of 1933 has had a similar beginning, and if the U.S. has any hope of reconstructing itself into the economic juggernaut of post-WWII super-power it once was, rather than the weak, debtor-nation  super-poser as it is now, Congress has to quit screwing around playing hyper-partisan games and bring it back. Otherwise known as the Banking Act of 1933, Glass-Steagall was one of the foundations of banking reforms after the collapse that led to the brutal Great Depression. Inasmuch as it was the longest, most widespread, and deepest depression of the modern era, it is the most used example of how the 21stcentury economy can descend into similar chaos. Some of the most devastating effects of the Great Depression were:

  • Personal income in the U.S. declined dramatically
  • Tax revenue, profits and prices dropped equally dramatically
  • International trade plunged by more than 50%.
  • Unemployment in the U.S. rose to 25%, and in some countries it rose as high as 33%.

Causes range from economic theories (i.e., supply and demand theories such as Keynesian, under-consumption or over-investment theories that point to economic bubbles; or malfeasance by banks, investors, etc.), to macroeconomic theories like Austrian economics that point to labor policies, money supply and central banking policies as the culprit of economic bubbles. Not coincidentally, the overlapping element to nearly all theories on economic bubbles point to a single common thread, regardless of the basic foundations of capitalism or socialism (or any intertwining thereof). That thread is the segment simply referred to as the banking sector.

Pulling On a Loose Thread

The Glass-Steagall Act was enacted in response to the failure of over 5,000 banks in the United States. One of the more prominent originating features of the bank failures began shortly after Britain decided unilaterally to return to the Gold Standard at WWI valuations of $10.98 / British £. The result was that the U.S. felt it must follow suit as Britain was the primary trading partner of the U.S. at the time and current-account trade policies were dependent upon common currency valuations. This return to the Gold Standard eroded U.S. investors’ confidence in the value of the dollar and thinking that they could lose their savings, depositors began withdrawing their funds en masse from U.S. banks. As deposits taken out from the bank increased, the money multiplier decreased, which means that money available in the economy to circulate slowed dramatically. This led to a decrease in the money supply, and an increase in interest rates causing a significant decrease in aggregate investment in U.S. stocks, bonds, etc. Because the U.S. government had committed to returning to the gold standard, the U.S. wasn’t able to engage in expansionary monetary policy because a central bank was non-existent to facilitate the changes in currency supply. This forced the U.S. to maintain high interest rates in order to attract international investors. The reaction to this policy however, was that the high interest also inhibited domestic business borrowing….the cost of borrowing capital for expansion or simple timing differences or even agricultural shortfalls was simply too high to risk failure. As France (Britain’s second largest trading partner) increased their interest rates to attract gold to their vaults, the U.S. had no choice but to follow suit and continue raising interest rates, further decreasing money supply, and deepening the downward spiral against the first law of economics….trade or die.

Enter Glass-Steagall

Originally, Glass-Steagall was enacted as part of FDR’s New Deal. The essential part of the act was to strengthen several important aspects that the U.S. economy lacked in order to effectively deal with the sinking U.S. economic cohesiveness. It gave tighter regulation of national banks to the Federal Reserve System so that changes in the overall economy could be met with changes in money supply to act as a counter-balance. Equally important, Glass-Steagall prohibited commercial bank from the sales of securities and created the Federal Deposit Insurance Corporation (FDIC), which insures bank deposits with a pool of money appropriated from member banks to mitigate the failure of any poorly managed commercial banking entities. Let me repeat what I feel was the most significant aspect…it prohibited commercial banks from engaging in the investment business. This part of the act purposely prohibited risky investments in favor of slow, steady growth because commercial bank depositors were seeking stability as opposed to risk vs. reward volatility to restore the banking public’s confidence that commercial banks would be forced to follow reasonable banking practices. With the forced separation of commercial and investment banks, ( by preventing commercial banks from underwriting securities) with the exception of U.S. Treasury and federal agency securities, and municipal and state general-obligation securities, the risk vs reward balance was once again established for banking vs gambling(investing). Likewise, investment banks could not engage in the business of receiving deposits, but those that were willing to take risks were rewarded if the investments proved successful. Investment banking could engage in securities underwriting and related activities, providing a viable market in securities. They could engage in setting up corporate mergers, acquisitions, and restructuring. Investment banks could also include services provided by brokers or dealers for transactions in the secondary market. Balance restored.

The Beginning of the End

In April 1998 Travelers Group announced an agreement to undertake the $76 billion merger between Travelers and Citicorp, and the merger was completed on October 8, 1998. The possibility remained that the merger would run into problems connected with federal law. However, The Glass-Steagall Act could plausibly hold the deal in abeyance for an undeterminable time while regulators and lawyers weighed in. To speed up the process, the parties wanting to proceed recruited ex-President Gerald Ford (Republican) to the Board of Directors and Robert Rubin ( who later became Secretary of Treasury during the Clinton Democrat Administration). With both Democrats and Republican on their side, the law was taken down in less than 2 years. The chief aim of money men (assisted by both Republicans and Democrats, but spearheaded by Phil Gramm( R ) Texas for decades was to roll back FDR’s New Deal. Anti-government rhetoric effectively hid the real agenda from public view, while the undoing of Glass-Steagall took decades and approximately $200 million in lobbying funds to accomplish. Contrary to the rhetoric of small government activists and both Republican and Libertarians alike, Capitalism ONLY works if greed and avarice are offset by laws and regulations to prevent fraudulent and deceptive practices. Free Markets are not created by profit goals that have been afforded the advantage of taking away the inherent risks that allow the risk vs reward formula to evolve naturally rather than with the removal of the “risk” aspect.

Flexibility and Sound Underpinnings

Flexibility is the hallmark and the cornerstone of capitalism’s longevity. Its main claim to success is its propensity to change in response to what ails it at any given time. Time and again it has reformed itself, according to the conditions in which it is operating, and thus survives and ultimately thrives. The great suffering brought on by the Great Depression gave rise to a movement to make capitalism stable and equal for everyone , which led to greater government ­protection and ­regulation. Conversely, to overcome the stagflation of the 1970s, capitalism once again morphed to fit the times and became more productive and innovative. Deregulation, free trade and free flows of capital spawned a global economic and technological boon. Today, amid the protracted downturn, capitalism has reached another point-in-time that screams out for another adaptation. The world’s financial sector is so unsound, and the destruction has been inflicted on so many average families, that capitalism needs to morph yet again, to become more inclusive and balanced and less prone to recurrent meltdowns. The Great Depression was created by capitalism-run-wild and fueled by 30 years of haphazard deregulation. The solution is a renewed ­government role to control the worst, not all, excesses of capitalism. Gramm-Leach-Bliley (the official act which repealed Glass-Steagall) allowed regulators to permit the banks to ignore risk, then bailed them out when their risky behavior became a threat to economic stability. Ever since, the Fed has helped Wall Street dodge reform by spoon-feeding it easy money, which allows bankers to turn profits at little cost and virtually no risk. In doing so, government has thwarted the self-regulating nature of capitalism. Not only has the U.S. not addressed the disastrous results of repealing the Glass-Steagall Act (also known as Gramm Bliley Leach Act),or The Commodity Futures Modernization Act of 2000 that allows speculators to dominate entire sectors of a market with very little actual capital, much less taking possession of the commodity.   The politician who’s handprints are all over the roll-back of the protective bills enacted as counter-balances to unfair speculation, is still actively lobbying for even more de-regulation on the Hill. Phil Gramm has been in the middle of every major financial disaster that has occurred in the U.S. since the early 1980’s. The results of Senator Gramm’s destruction include the Savings & Loan Collapse, and Enron (through his wife, Mrs Wendy Gramm, the woman who, as a former chief government regulator of the energy business, deregulated electrical power so that Enron could speculate in electricity. Mrs. Phil Graham turned out to have joined the corporate board of Enron shortly after she resigned her government position. Her husband, now-Senator Phil Gramm, was an enormously influential Republican senator. He received $97,000 in campaign donations from Enron in the preceding dozen years).   Senator Gramm was also in the middle of the real estate / Wall St. crash at the end of 2008 where he had been employed by Swiss mega bank UBS as a lobbyist and investment banker since leaving the Senate in 2002.   The 1999 Gramm-Bliley-Leach Act did not make sweeping changes in the types of business that may be conducted by an individual bank, broker-dealer or insurance company. Instead, the act repealed the Glass-Steagall Act’s restrictions on bank and securities-firm affiliations. It also amended the Bank Holding Company Act to permit affiliations among financial services companies, including banks, securities firms and insurance companies. The new law sought financial modernization by removing the very barriers that Glass-Steagall had erected to protect the economy and small investors from fraud, cronyism, and corruption. The time-lines and the ensuing results that have taken place since 1999are mirror images of the causes of the Great Depression. Repealing Gramm-Blilely-Leach is one of the most important steps the U.S. could possibly take to avoid the thundering herd of bison bearing down on us. “Those who don’t know history are destined to repeat it”. [Edmund Burke, January 12, 1729-July 9, 1797] No truer words were ever uttered.

Harvey Gold

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  2 comments for “Forget Dodd-Frank: Reinstate Glass Steagall

  1. Mechasr
    February 20, 2012 at 11:19 pm

    Great article. What I like is the historical explanation of how Glass-Steagall came about and how it came to be repealed.
    Why would they repeal an act that worked so good for so long? Apparently because it impeded profits for insurance company and banks.

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