Discourse of the Day, It's the Economy Stupid

It’s the Economy Stupid- Glass-Steagall

If you’ve been paying attention to the presidential campaign trail at all (and I wouldn’t blame you if you weren’t) then you’ve likely heard the phrase Glass-Steagall pop up on more than one occasion. In fact it was mentioned no less than a dozen times during the first democratic presidential debate. Those of you without a background in finance or possessed of an encyclopedic knowledge of 1930’s congressional legislation you be asking what exactly it is that everyone is talking about and why the old guy with crazy hair so worked up over it.

In modern politics Glass-Steagall is a specific reference to the sections of the 1933 Banking Act that restricted commercial banks and securities firms from affiliating with one another. In 1999 a Republican congress repealed these sections by an overwhelming majority. Many people cite this repeal as one of the causes of the 2008 financial crisis and there has been a large push by Senators Bernie Sanders and Elizabeth Warren to bring back these provisions in order to avoid a repeat of the 2008 meltdown.

That one paragraph is a perfect summation of the events that have got us to this point and like most things in economics the points maintained within it are both simple and incredibly complex. To begin with I’ll need to explain exactly what commercial banks and securities firms do. A commercial bank is the type of bank that you are most accustomed to dealing with. It accepts deposits and issues loans. A securities firm on the other hand deal with the purchase and sales of bonds, stocks, and a myriad of other investments as well as assisting companies in their initial public offerings (IPOs). Securities firms or as they are also known investment banks have a much higher level of risk. The fear is that when a company is allowed to pursue both types of banking under one roof it make people’s checking accounts vulnerable to these high risks. This fear was realized in the 1929 stock market crash and subsequent depression which were the original impetus for Glass-Steagall.

Understanding the law and its origins we must examine then the claim that the repeal of Glass-Steagall had a direct role in creating the 2008 financial crisis. The truth is that while this is a popular narrative it is mostly a fallacy. By the time Glass-Steagall was repealed in 1999 its effectiveness had almost entirely been eroded by congressional and regulatory exceptions dating back to the 1960’s. The first two financial institutions to fail were Bear Sterns and Lehman Brothers neither of which had ties to commercial banking. Neither did Merrill Lynch or AIG the next two to fail. While it can be argued that banks getting larger contributed to an era of recklessness and excess, the primary culprit for the 2008 crash were bad loans and shell-game accounting coming home to roost.

However the 2008 crisis did bring about the concept of “Too Big To Fail”. (Which if you ask me undermines the entire point of a free market and makes us more Socialist than Bernie ever could, but that’s a post for another time.) The American taxpayer was asked to cover the debts of these reckless financial institutions with zero percent interest loans. (Less than what 18 year old students get on their loans which is bullshit but also a topic for another time.) What no one disputes is that since the repeal of Glass-Steagall banks have only gotten bigger and when the next financial crisis comes along “too big to fail” won’t even begin to cover what we are dealing with.

So did repealing Glass-Steagall cause the 2008 crash? No. Will reinstating it definitely prevent another financial meltdown? No. Is it an absolutely vital piece of legislation that needs to be brought back immediately? You bet your ass it is.

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