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Glass Steagall Repeal Made Crisis Worse

The repeal of Glass Steagall itself did not cause the financial crisis. However, the repeal did help make the crisis worse.

I bring this up because there has been a series of straw man articles claiming Glass Steagall was not a cause in the crisis. This misstates the impact and the broader context. The overturning of the successful 1933 legislation was part and parcel of an ideology that WAS a major factor in the crash: The erroneous belief system that banks can self-regulate. This manifested in a variety of bad ideas, poor oversight and worse legislation.

The finacialization of the American economy allowed banks to become bigger, more complex, and greatly leveraged. When it all came down, the crisis was broader, deeper and more dangerous than it would have been otherwise.

Glass Steagall’s repeal, after 25 years and $300 million worth of lobbying efforts, culminated decades of radical deregulation.

New-fangled derivatives? No oversight, reporting, or reserves necessary, courtesy of the Commodities Futures Modernization Act of 2000 (CFMA). You can thank Enron Board Member Wendy Gramm, and her Senator husband Phil Gramm, for that one. Subprime-Lend-to-sell-to-securitizers business model? Those are the financial innovators! At least, that is what Alan Greenspan called them, and why he refused to oversee them as Fed chair. Rules on SEC leverage? Let’s create a special exemption from the law for just 5 investment banks.

And so on. The list of radical deregulation and false beliefs is long and painful and dangerous and costly.

Of course “reputational risk” would serve as a deterrent to poor decision making! No bank would ever behave so recklessly as to put their own hard won status on the line — forget their very existence.

How’d that idea work out?

Had Glass Steagall not been repealed in 1999, we would still have had a financial crisis. Ultra low rates, the abdication of lending standards, the Commodities Futures Modernization Act of 2000 (and other acts of idiocy) all made sure of that.

With Glass Steagall, there would not, could not, have been a Citi/Travelers merger, and competitors would not, could not have bulked up the way they did. Major money center banks most likely would have been smaller, more manageable, more easily wound down. Arguably, too big to fail might not have been the rule, and bailouts might not have been necessary. This is, of course, mere supposition.

The misguided philosophy that led to the repeal of Glass Steagall also did contribute mightily to the crisis. The radical deregulatory philosophy from fools such as Alan Greenspan and Phil Gramm was certainly a major factor — and the Glass Steagall repeal was part of that continuum of bad ideas.

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What we should be discussing are the corrupting influence of crony capitalism and radical deregulation; instead, we find ourselves forced to defend capitalism and free markets. We should be finding ways to definancialize the US economy, and reduce the influence of bankers.

 

Previously:
Volcker: Reinstate Glass Steagall (September 24th, 2009)

Gramm: Glass Steagall Repeal Irrelevant (November 19th, 2009)

What’s Wrong? The Deregulators (April 8th, 2011)

A Brief History Lesson: How We Ended Glass Steagall (May 17th, 2012)

See also:
Breaking Up Is Hard to Do (WSJ, July 27, 2012)

Let’s shatter the myth on Glass-Steagall (WaPo, July 28, 2012)

This post originally appeared at The Big Picture and is posted with permission.

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Emre Deliveli The Kapali Carsi

Emre Deliveli is a freelance consultant, part-time lecturer in economics and columnist. Previously, Emre worked as economist for Citi Istanbul, covering Turkey and the Balkans. He was previously Director of Economic Studies at the Economic Policy Research Foundation of Turkey in Ankara and has has also worked at the World Bank, OECD, McKinsey and the Central Bank of Turkey. Emre holds a B.A., summa cum laude, from Yale University and undertook his PhD studies at Harvard University, in Economics.

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