The American Spectator : The Spectacle Blog : Glass-Steagall II

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Nate Silver touches on the issue of financial regulation reform and the Glass-Steagall II measure that Paul Volcker is advocating, and makes an observation about the looming legislative battle that seems astute:

From a 30,000-foot view, the debate will be between the Volckerists and the Summersists, with the Volckerists arguing that large financial institutions need to be broken up -- probably through something resembling a modern Glass-Steagall Act -- and the Summersists arguing instead for more extensive regulations.

The 'hard', online left will almost certainly take the Volckerist position. In fact, I expect this to be the "public option" of 2010, the badge of pride that "movement progressives" will use to distinguish themselves from "kleptocrats".

This is exactly the split that I was referring to in my earlier post on Volcker. Most people don't know or care about even the broad outlines of financial regulation, except that the left is usually in favor of more and the right in favor of less regulation of any kind. The kinds of regulations that Larry Summers or Austan Goolsbee would propose would be more intricate and hard to follow than Volcker's plan, which is readily understandable: split up the banks. It seems like a natural rallying point for the liberal left: financial reform without splitting up the banks is no reform at all.

Of course, someone will have to come up with a name for it that's as snappy as "public option." I personally cannot think of a way to make prohibiting banks from engaging in both commercial and investment banking activities seem sexy.

View all comments (6) | Leave a comment

Pasadena Phil| 10.21.09 @ 7:54PM

This is where conservatives and Republicans are just dead wrong. I'm a professional investment manager and I don't understand where people get the idea that capitalism is the only game in the world that works best when there are no rules (aka regulations). The issue is not whether there should or should not be regulations but whether those regulations promote fair and efficient markets. Revoking the Glass-Steagall Act of 1938 was an epic mistake. The same act institutionalized all of the problems that created the Long Term Capital disaster and the Enron disaster. They also negated a very efficient regulatory tactic of making sure that investment banks, commercial banks and insurance companies, as conflicting assets as their can be, separate. Keeping them separate made it unnecessary to build a large bureaucracy to regulate the problem.

By accepting "too big to fail", we are inviting a monstrous bureaucracy in lieu of the simple rule Glass-Steagall provided. Spare me the argument that the 1998 act that repealed it did contain some much needed overhaul if the banking industry. It didn't need that part of it and it should be reversed.

I'm 100% behind Paul Volker with this as all patriotic capitalist conservatives should be.

The US Constitution is the supreme regulatory document in the US.

Mary Louise| 10.21.09 @ 8:43PM

probably through something resembling a modern Glass-Steagall Act

What was wrong with the original?

Bob Brinker from Money Talk said repealing this played a big role in what led to to economic fallout of last year.

globalizer| 10.21.09 @ 9:27PM

Breaking up the big banks so that none are too big to fail is probably a good idea, and not a "left" vs. "right" issue. However, the idea that a new Glass Steagall would be THE solution is pie in the sky. Bear Stearns and Lehman were pure Investment Banks, the repeal of Glass-Steagall had nothing to do with their situations, and their failures caused great harm. The repeal of Glass Steagall was not the main problem. The main problem was government meddling in the mortgage markets to reduce lending standards and to allow dodgy mortgage companies and banks to leverage the system by selling dodgy securitized paper to institutions with implicit government guarantees, i.e., to Freddie and Fannie. The government has to get out of the game of saying Heads you win, Tails we (the taxpayers) lose. Won't happen with this crew, though. 80% of all mortgages are now guaranteed by Uncle Sam, i.e., us. Welfare for the banker class that contributes disproportionately to Democrats (and those who can't really afford mortgages), anyone?

S.L. Toddard| 10.22.09 @ 10:01AM

"By accepting "too big to fail", we are inviting a monstrous bureaucracy in lieu of the simple rule Glass-Steagall provided"

I agree with this sentiment. If an institution is "too big to fail", it is TOO BIG TO EXIST in the free market. Any institution "too big to fail" already by definition exists *outside* the free market, as it can not face the penalties the free market imposes upon it when it does fail, and is immune to the incentives to operate responsibly inherent in a "free market". To repeat: any system with institutions that are "too big to fail" is by definition NOT a "free market".

We must either allow institutions that are "too big to fail" to fail, or ensure that no institutions become "too big to fail".

S.L. Toddard| 10.22.09 @ 10:17AM

Mr. Lawler, you write that Volker's suggestions are "coming from too far to the left". I would ask you: what is more leftist, government subsidized financial mega-corporations, or regulations intended to preclude gov't subsidization? Which is more likely to be rife with corruption?

I would say that neither is particularly "conservative", but that the latter would result in a more stable, freer market than the former. I think conservatives make a mistake when they focus on Big Government while ignoring Big Business entirely, because they are often one and the same entity - Big Business *owns* big government. Tim Geithner and his cronies/aids all made zillions working in the financial industry, and are now enthroned in Washington, supervising the transfer of hundreds of billions of dollars *to their former (and probably future) employers*. This scenario is more the rule than the exception.

We need to stop thinking of our government and our mega-corporations as separate, antagonistic entities. It is commonplace for agents of our largest corporations write the very legislation intended to "regulate" them, thus perpetuating the rapid centralization of wealth and power in this country from the American people to a small cabal of well-connected political/corporate/financial elites.

The line between the public and private sectors has been blurred to the point of nonexistence, and is the direct cause of the "too big to fail" mentality.

Elie Elhadj| 10.25.09 @ 6:54AM

To Save Commercial Banking From Gamblers, Re-enact Glass-Steagall Act

In December 1863, H. McCulloch, U.S. Comptroller of the Currency and later Secretary of the Treasury, wrote to all national banks. Here are some of the paragraphs.

“Let no loans be made that are not secured beyond a reasonable contingency. Do nothing to encourage speculation. Give facilities only to legitimate and prudent transactions.

“Distribute your loans rather than concentrate them in a few hands. Large loans to a single individual or firm, although sometimes proper and necessary, are generally injudicious, and frequently unsafe. Large borrowers are apt to control the bank.

“If you doubt the propriety of discounting an offering, give the bank the benefit of the doubt and decline it. If you have reasons to distrust the integrity of a customer, close his account. Never deal with a rascal under the impression that you can prevent him from cheating you.

“Pay your officers such salaries as will enable them to live comfortably and respectably without stealing; and require of them their entire services. If an officer lives beyond his income, dismiss him; even if his excess of expenditures can be explained consistently with his integrity, still dismiss him. Extravagance, if not a crime, very naturally leads to crime.

“The capital of a bank should be reality, not a fiction; and it should be owned by those who have money to lend, and not by borrowers.

“Pursue a straightforward, upright, legitimate banking business. ‘Splendid financing’ is not legitimate banking, and ‘splendid financiers’ in banking are generally either humbugs or rascals.”

The McCulloch teaching is as relevant today as it were in 1863. Accepting and managing society’s saving is a sacred responsibility bestowed by the legislator exclusively upon commercial banks. Investment, insurance, and brokerage firms are not banks and their executives are not bankers. That investment firms are called “banks” is a misnomer. Investment managers will not be called bankers here.

The deposit-taking culture of commercial banking contrasts with the culture of investment companies. As custodians of society’s saving, commercial banks are highly regulated. Their funding is sourced primarily from people's deposits. By contrast, investment firms are prohibited from seeking customers’ deposits (they fund their operations from the money markets); thus, they are less regulated. Different funding sources and regulations evolved into two very different cultures, value systems, temperaments, and personality types; thus, attracting two different kinds of people. Commercial banking appeals to cautious individuals. Commercial bankers are generally dedicated to steady, long-term banking relationships with depositors and borrowers. Bankers are taught to observe prudence in risk management and avoid speculation. Bankers grow to view risk control structures with respect. They earn relatively modest but comfortable salaries. On the other hand, investment managers are genetically risk-takers. They are aggressive, short-term transaction-by-transaction oriented salesmen. With performance-bonus schemes and scant training in risk analysis, investment managers regard control structures as an impediment to profitable deals. To such individuals, commercial bankers are “boring” and “unimaginative”.
The liberalization years of the Reagan administration (1981-1989) led to the repeal in 1999 of the Glass-Steagall Act of 1933. The repeal removed the wall between commercial banks and the other types of financial organizations.

The current banking meltdown is in a great measure the product of deregulation and eight years of a Bush administration contemptuous of regulation. Commercial banks were cobbled together with investment, insurance, and brokerage companies despite their very different cultures. Non-bankers, “rascals” and “splendid financiers” took charge of the billions in people’s saving. The merged businesses became wildly diversified and colossal--impossible to manage successfully. In pursuit of huge performance bonuses, an era of go-go banking was ushered into the previously controlled commercial banking environment, with the result that many of the once highly respectable deposit-taking institutions became irreparably damaged.

The current debacle is a result of the collective failure of "rascals", "splendid financiers", greedy lenders, negligent government supervisors, obsequious internal auditors, submissive external auditors obsessed in lucrative consulting contracts with the companies they audit, as well as those pontificating rating agencies’ “experts” who are always one step behind the events and who get paid by the firms they rate.

To protect national saving, investment firms must be kept away from commercial banks. The repeal of Glass-Steagall Act was the primary misstep in creating the conditions, which resulted in the crisis we face today. Astonishingly, in the midst of this unraveling crisis, Goldman Sachs and Morgan Stanley, the two leading firms of an industry that contributed greatly to the current banking disaster, were upgraded to full commercial banking status by the Federal Reserve Bank. Notwithstanding the short-term arguments in favor of the upgrade, I predict that the long-term effects of this action will prove to be a grave mistake.

The wall around commercial banking must be rebuilt. Reviving the provisions of Glass-Steagall Act is crucial. Strict governmental control over commercial banks must be restored. External auditors should perform one function only: auditing. Management consultancies should be separated from audit firms.

The practice that grew in recent years of compensating senior executives with mainly performance bonuses has had disastrous repercussions. Performance bonuses can be soul destroying. In their pursuit of self-enrichment, executives are tempted to not only cut corners on professional and ethical standards but also ignore the spirit of the law, and even violate the law (in the hope that they’ll never be caught). The monumental losses that surfaced in 2008 render the billions of bonus dollars paid to executives a travesty. Performance bonuses have also created obscene disparities in employee compensation within even the same bank, between the managers of the investment divisions, on one hand, and the managers of the commercial banking divisions. Such disparities of incomes replaced the old institutional culture of loyalty, commitment, and collegiality by a culture of disloyalty, exploitation, and I-only-work-here syndrome.

Government regulators should ensure that senior bank executives and board members are “fit” to serve. To be fit, a banker must not only be qualified technically but also psychologically suitable. The current approval process conducted by central banks of senior bankers is cursory. This process should include behavioral psychological testing to keep gamblers away. If drunks are not allowed to drive cars why should gamblers be allowed to play the markets with society's saving?!

Sincerely,
www.daringopinion.com