The Glass-Steagall myth

According to the left, the financial crisis was caused in large measure by the repeal of the Glass-Steagall Act, making it possible for local commercial banks to make risky investments.  Business & economics columnist Steven Pearlstein–who is himself a liberal–busts that myth:

I was watching “The Newsroom” last week, the latest hit show by the producer and screenwriter, when the brainy-but-beautiful economics correspondent for the fictional cable news network was explaining to her gutsy-but-impulsive executive producer how the world’s financial system recently came to the brink of collapse.

“So after the Great Depression, Congress wanted to put a firewall between the [banks and the] investment banks. They wanted to make sure that Wall Street could melt to the ground and the commercial banks wouldn’t be touched. They passed a law, the Glass-Steagall Act. Now you could be Gordon Gekko [tycoon in the movie “Wall Street] or George Bailey [small-town banker in the movie classic, “It’s a Wonderful Life”], but you couldn’t be both.”

Then, explains the brainy-but-beautiful correspondent, Ronald Reagan launched a two-decade push toward deregulation, which culminates in the repeal of Glass-Steagall in 1999. Suddenly, Gordon Gekko could make risky bets with George Bailey’s deposits, and the rest, as they say, is history.

It was vintage Sorkin: eloquent, fast-paced dialogue that perfectly channels the liberal political/cultural zeitgeist, transforming what appears to be a complex story into a simple morality play.

The only thing is, it’s not true — not even close. Yet it has been repeated so many times — on PBS and NPR, in the liberal blogosphere, on very-serious Op-Ed pages, in an Oscar-winning documentary — that whenever I give a talk to a group of college students about the financial crisis, the first question predictably is, “Yeah, isn’t it all really about the repeal of Glass-Steagall.”

But why let facts get in the way of a good screenplay?

Facts such as that Bear Stearns, Lehman Brothers and Merrill Lynch — three institutions at the heart of the crisis — were pure investment banks that had never crossed the old line into commercial banking. The same goes for Goldman Sachs, another favorite villain of the left.

The infamous AIG? An insurance firm. New Century Financial? A real estate investment trust. No Glass-Steagall there.

Two of the biggest banks that went under, Wachovia and Washington Mutual, got into trouble the old-fashioned way – largely by making risky loans to homeowners. Bank of America nearly met the same fate, not because it had bought an investment bank but because it had bought Countrywide Financial, a vanilla-variety mortgage lender.

Meanwhile, J.P. Morgan and Wells Fargo — two large banks with big investment banking arms — resisted taking government capital and arguably could have weathered the crisis without it.

Did U.S. investment banks create a shadow banking system and derivatives market outside the normal regulatory framework that encouraged sloppy lending and created what turned out to be toxic securities? You betcha.

And did regular banks make some of those bad loans and buy up some of those toxic securities? Yes, they did.

But that was as much a problem at the banks and investment banks that combined as those that remained independent. More significantly, the bulk of the money that flowed through the shadow banking system didn’t come from government-insured bank deposits. It came from money market funds, hedge funds, pension funds, insurance companies, foreign banks and foreign central banks.

via Steven Pearlstein: Shattering the Glass-Steagall myth – The Washington Post.

About Gene Veith

Professor of Literature at Patrick Henry College, the Director of the Cranach Institute at Concordia Theological Seminary, a columnist for World Magazine and TableTalk, and the author of 18 books on different facets of Christianity & Culture.

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  • SKPeterson

    “The same goes for Goldman Sachs, another favorite villain of the left.”

    You mean the same Goldman Sachs that is riddled through and through with former Bush and Clinton Treasury officials and continues to have a revolving door with Obama’s Treasury? That villain of the Left? The one that often acts to marshal campaign funds for Left liberal politicians like it’s done for decades? That Goldman Sachs? Or is it the Goldman Sachs that is called MF Global that they’re thinking of? You know, the futures trading firm headed by uber Democrat politico and all around financial wizard Jon Corzine that illegally traded and lost customer funds, despite any sort of regulations to the contrary that were being overseen by certain friends in high places in the Obama administration. Maybe that Goldman Sachs?

    Or maybe they’re thinking of the financial manipulations engineered by George Soros, a well-known, but still shadowy, figure of the radical Right, almost as insidious as the Koch brothers. Oh wait. Nevermind. He’s the guy who funded MoveOn.org. He’s on the Left. So, nothing to see there. Greed is the province of the Right despite any evidence to the contrary that would disrupt our ability to create scintillating dialog for our next screenplay or show script.

  • SKPeterson

    “The same goes for Goldman Sachs, another favorite villain of the left.”

    You mean the same Goldman Sachs that is riddled through and through with former Bush and Clinton Treasury officials and continues to have a revolving door with Obama’s Treasury? That villain of the Left? The one that often acts to marshal campaign funds for Left liberal politicians like it’s done for decades? That Goldman Sachs? Or is it the Goldman Sachs that is called MF Global that they’re thinking of? You know, the futures trading firm headed by uber Democrat politico and all around financial wizard Jon Corzine that illegally traded and lost customer funds, despite any sort of regulations to the contrary that were being overseen by certain friends in high places in the Obama administration. Maybe that Goldman Sachs?

    Or maybe they’re thinking of the financial manipulations engineered by George Soros, a well-known, but still shadowy, figure of the radical Right, almost as insidious as the Koch brothers. Oh wait. Nevermind. He’s the guy who funded MoveOn.org. He’s on the Left. So, nothing to see there. Greed is the province of the Right despite any evidence to the contrary that would disrupt our ability to create scintillating dialog for our next screenplay or show script.

  • Klasie Kraalogies

    Nice rant, SKP – and I totally agree.

    They should have listened to Mark Carney – last fall there was this famoust dust-up between Carney and Dimon from JP Morgan, where the latter went balistic over Carney’s suggestions about banking reform. Of course, subsequently, JP Morgan had to take a $2 billion dollar loss in May – precisely because Dimon would not listen to Carney.

    http://business.financialpost.com/2011/09/26/jpmorgan-chief-lashes-out-at-mark-carney-over-bank-reform-ft/

  • Klasie Kraalogies

    Nice rant, SKP – and I totally agree.

    They should have listened to Mark Carney – last fall there was this famoust dust-up between Carney and Dimon from JP Morgan, where the latter went balistic over Carney’s suggestions about banking reform. Of course, subsequently, JP Morgan had to take a $2 billion dollar loss in May – precisely because Dimon would not listen to Carney.

    http://business.financialpost.com/2011/09/26/jpmorgan-chief-lashes-out-at-mark-carney-over-bank-reform-ft/

  • Klasie Kraalogies

    Excuse the spelling mistakes above – famoust=famous, balistic=ballistic.

  • Klasie Kraalogies

    Excuse the spelling mistakes above – famoust=famous, balistic=ballistic.

  • Steve Billingsley

    Greed and bad judgment are not the province of the Right or the Left. They pretty much cut across every human line. I have made some exceedingly dumb financial decisions in my day, but because it was my own money and was hundreds or thousands of dollars (as opposed to millions, billions or trillions), the damage was pretty limited. But greed and stupidity were behind those decisions and if I would have had access to more funds or more power I could have done a lot worse.

    There should definitely be more accountability for the movers and shakers in the financial (and political) world who made this mess, but let’s not pretend that partisan politics was the driving force behind all of this. It was human greed and lust for power, nothing more, nothing less.

  • Steve Billingsley

    Greed and bad judgment are not the province of the Right or the Left. They pretty much cut across every human line. I have made some exceedingly dumb financial decisions in my day, but because it was my own money and was hundreds or thousands of dollars (as opposed to millions, billions or trillions), the damage was pretty limited. But greed and stupidity were behind those decisions and if I would have had access to more funds or more power I could have done a lot worse.

    There should definitely be more accountability for the movers and shakers in the financial (and political) world who made this mess, but let’s not pretend that partisan politics was the driving force behind all of this. It was human greed and lust for power, nothing more, nothing less.

  • SKPeterson

    I wouldn’t mind if the regulators actually allowed firms to go bankrupt, and punished firms who illegally or improperly covered their positions with client money, without the express consent or knowledge of the individuals whose money is being “transferred.” This is part and parcel of the problem with the Wall Street Big Bank (Toronto doesn’t seem to have the same problem, but RBC appears to have gotten in trouble here, KK) mentality that is indicative of the regulatory capture, rent-seeking behavior, and moral hazard feedback loop encouraged by regulators, politicians, and bankers that incentivizes excessively risking financial instruments, but socializes the losses onto the public. I’m sorry, but that isn’t capitalism. At least not the free market variety. It’s some sort of crypto-fascistic mercantilism dressed up as “ruthless capitalism.” It is ruthless, but only because it is underwritten and coddled by government.

    Instead, why not let these guys go under when they invest in things they don’t understand or take positions that are overly risky? Rewarding them by covering their bets and declaring them to be too big to fail merely encourages them to become big and then fail far more often than they otherwise would. We now have a system that is biased towards encouraging more of the same types of behavior, under a regulatory regime that is designed to protect and perpetuate it. Politicians, bank execs and regulators win, capitalism and the people lose.

  • SKPeterson

    I wouldn’t mind if the regulators actually allowed firms to go bankrupt, and punished firms who illegally or improperly covered their positions with client money, without the express consent or knowledge of the individuals whose money is being “transferred.” This is part and parcel of the problem with the Wall Street Big Bank (Toronto doesn’t seem to have the same problem, but RBC appears to have gotten in trouble here, KK) mentality that is indicative of the regulatory capture, rent-seeking behavior, and moral hazard feedback loop encouraged by regulators, politicians, and bankers that incentivizes excessively risking financial instruments, but socializes the losses onto the public. I’m sorry, but that isn’t capitalism. At least not the free market variety. It’s some sort of crypto-fascistic mercantilism dressed up as “ruthless capitalism.” It is ruthless, but only because it is underwritten and coddled by government.

    Instead, why not let these guys go under when they invest in things they don’t understand or take positions that are overly risky? Rewarding them by covering their bets and declaring them to be too big to fail merely encourages them to become big and then fail far more often than they otherwise would. We now have a system that is biased towards encouraging more of the same types of behavior, under a regulatory regime that is designed to protect and perpetuate it. Politicians, bank execs and regulators win, capitalism and the people lose.

  • Klasie Kraalogies

    SKP, I call it the difference between regulations, and regulatory shenanigans.

  • Klasie Kraalogies

    SKP, I call it the difference between regulations, and regulatory shenanigans.

  • SKPeterson

    KK @ 7 – That’s the concept of regulatory capture and rent-seeking in a nutshell.

  • SKPeterson

    KK @ 7 – That’s the concept of regulatory capture and rent-seeking in a nutshell.

  • Joe

    The other inaccuracy in the explanation is the insinuation that Reagan started the modern deregulation movement. The first major deregulation efforts began under Nixon (the man who signed the EPA into existence) and included people from both parties. In fact, the bill that deregulated the airline industry was authored by Ted Kennedy and signed into law by Jimmy Carter..

  • Joe

    The other inaccuracy in the explanation is the insinuation that Reagan started the modern deregulation movement. The first major deregulation efforts began under Nixon (the man who signed the EPA into existence) and included people from both parties. In fact, the bill that deregulated the airline industry was authored by Ted Kennedy and signed into law by Jimmy Carter..

  • Lumpenkönig

    An excuse is nothing more than an explanation of failure. Churchill

    Please ignore the disinformation by the Washington Post.

    Instead, enjoy this video (transcript is below the video):

    http://www.presstv.ir/detail/2012/06/28/248349/shadow-banking-system-greater-visible-banking-system/

    For further reading:

    Max Keiser:
    http://maxkeiser.com

  • Lumpenkönig

    An excuse is nothing more than an explanation of failure. Churchill

    Please ignore the disinformation by the Washington Post.

    Instead, enjoy this video (transcript is below the video):

    http://www.presstv.ir/detail/2012/06/28/248349/shadow-banking-system-greater-visible-banking-system/

    For further reading:

    Max Keiser:
    http://maxkeiser.com