This is one area where I would like feedback from my readers. My view is that the repeal of Glass-Stegall had little impact on the crisis. Most of the crisis occurred as a result of ordinary failures in investment banking, and commercial banking, with little change from combining them.
I would argue that the overall model for investment banking failed. No major investment bank survived the crisis intact. Goldman Sachs and Morgan Stanley had to seek banking charters to survive and receive help from the Treasury/Fed (one entity, but like Janus, two faces). Everyone else needed help from the Feds, or failed, or merged.
I would also argue that the overall model for commercial banking failed, with many making loans that were horrendously underwritten.
So, what aspects of the crisis stemmed from the repeal of Glass-Stegall? Remember, the Fed was chipping away at it for some time. Feel free to comment below, but if you don’t want to do that, email me. Thanks.
I’m neither an expert nor a historian, though I’ve paid dearly for my efforts to learn about finance.
My mother used to say that if you have enough time, are mean enough, think enough bad thoughts, practice enough voodoo, cast enough curses and use just the right amount of arsenic, you can kill man.
I’d say revoking Glass-Stegall was somewhere between bad thoughts and voodoo in terms of being the cause. Changing investment banks from partnerships to publicly traded institutions was closer to arsenic.
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The cause of the financial problems over the past several years is that man is a social animal (lemming), and feels secure in his judgments only when he has company. I’ve been a financial analyst for too long, and the mortgage/real estate problem infected banks that were big as well as small ones. It affected banks in the UK, US and Spain.
Property prices were up in all of those markets. The exceptions were – Germany, with a rental culture, and -in the US the only credible exception was Texas, where they had a gargantuan real estate disaster in the late 80’s-early 90’s that people there still remembered, which caused enough people to proceed with caution.
Capital requirements need to be enforced to prevent unbridled lending/speculation. Regulatory capture by the banks allowed for 30 to 1 leverage, and as ever, too much leverage is the prerequisite for financial failure. Each individual institution pushes against the capital rules, thinking that they can do a little better with just a bit more leverage for their loan book. Collectively, they all do the same damn thing, hurting margins and extending credit risk to use the leverage they so desired. Brain dead institutions of all stripes with too much money to lend- CAUSED by inadequate capital requirements, was the problem. Larger, well capitalized institutions, intelligently managed with different markets in which to allocate capital, should be a net benefit to society. The test of this hypothesis is to see how Citigroup and JP Morgan do over the next decade.
The perverse thing is that the banks will fight capital requirements, but when loan demand resumes a less levered system will allow for loan margins to expand as risk capital is scarcer and not every monkey masquerading as a bank or CLO manager can get funded. That is when the financials will shine in the stock market, not that anyone believes that can possibly happen!
David,
I’d say you are right and wrong. I agree that the repeal of Glass-Steagall had little to do with the creation of the crisis. But I believe it had quite a lot to do with the response. It gave us ‘too big to fail’, which can be partially read as ‘too big to make good on via FDIC’. The repeal created a situation where the creative destruction of capitalism meant destruction of far more than just some investment bankers and their investors. With G-S still in place, the response to the housing crises driven credit crises and the added burden placed to taxpayers as counter-party guarantors could both have been less.
It had a huge impact on the crisis. Watch the PBS Frontline documentary “The Warning” and that will get you well on your way to understanding why.
Can you be a little more specific — I avoid video because it takes so much time vs reading. The Wikipedia article seems to indicate the effect was slight:
http://en.wikipedia.org/wiki/Gramm%E2%80%93Leach%E2%80%93Bliley_Act
Most of the things done that people attach as a reason for the crisis were legal before and after Glass Stegall’s repeal. In some ways, the repeal may have been emblematic of a loose regulatory culture, one where banking and securities regulators did not use the tools that they were already allowed to use.
sorry look at my post below i meant to leave it as a reply
i think it will be easier and more explanatory if you go to the documentary’s site:
http://www.pbs.org/wgbh/pages/frontline/warning/
have a quick looksie and you can decide if its relevant to your analysis and if you already know this
Also, Simon Johnson and James Kwak over at http://baselinescenario.com have written extensively about Glass-Steagall, its repeal and its concequences and in their opinion why it should be reinstated
The overall model for commercial banking failed because they were engaged in the very activities G-S prohibited ie speculative securization and derivatives that created incentives for abomindable lending for short term bank profit. If banks could not off-load the bad loans they would not have done the lending. To add to the speculative frenzy they created derivatives to profit from the demise of the very issues they had underwritten. None of this would have occurred w/o the repeal of G-S.
And yes, the IB model failed; but if G-S were intact then the failure would not have cascaded through the sytem because banks would not have been so deeply intertwined with the IBs via speculative derivatives and securitizations.
G-S mattered; but it must be viewed through a speculative activity lens and not an organizational one ie it’s not about the “combining” but rather the activities. The entire crisis was due to the mortgage backed securities market and related derivatives. Under G-S those activities would be restricted to IBs.
David, Funny you would be thinking about the banking industry this week….
Please check out the most recent post at MacroRants about The Future of Banking.
I think the banks are making the same business strategy errors that Detroit did — which in the cast of banks (both commercial and investment) lead to faster and faster disintermediation.
PS David — Greg let me post the above comment under his ID. My wordpress login didn’t work for your site?