Back in the old days, there was this thing called “Glass-Steagall”. No, it was not fancy German stemware or French crystal; it was a Federal Law that mandated relative sanity for financial markets and banks, which separated the commercial banking industry from the more volatile investment and trading businesses of Wall Street. It worked quite well for a long time. However, because it worked so well, the banking industry did not like Glass-Steagall. They saw it as limiting their profit opportunities, and so they lobbied Congress for many years until Glass-Steagall was finally done away with. Commercial banks have never been the same since.
The Glass-Steagall Law was passed by Congress in 1932-1933 as part of a larger legislative package known then as “The Banking Act of 1933”, an anti-deflation law which included the introduction of Federal Deposit Insurance, expanded powers for the Federal Reserve and most importantly, barring commercial banks from engaging in certain investment banking, trading and investment sales activities. Sponsored by Senator Carter Glass of Virginia and Congressman Henry Steagall of Alabama, it was intended to keep banks solvent by barring them from talking on too much investment risk.
Though many big banks had been trying since the 1960s to dismantle Glass-Steagall in order to get into what they saw as more profitable investment and trading lines, the big push to get rid of Glass Steagall came in the late 1990s as stock prices soared and investment houses reaped big profits. Banking executives grew envious of the huge net earnings pocketed by the likes of Goldman Sachs and other investment firms, and resolved to kill Glass-Steagall once and for all.
By 1999, the pressure from big banks was too much, and Glass-Steagall was fianally repealed by the Gramm–Leach–Bliley Act; and the door to big banks operating as high-powered investment players was thrown wide open.
Ever since, we’ve witnessed a succession of various baking scandals, which included the over leveraging of asset backed securities, off balance sheet chicanery and a variety of other financial shenanigans. In addition, there have been multiple cases of cavalier capitalists and bumbling traders making massive errors that cost their banks, their shareholders, depositors and ultimately taxpayers hundreds Billions of dollars. The recent “London Whale” incident at JP Morgan is only one of many stories like it since the repeal of Glass-Steagall.
Recently, there have been many calls in Congress and among the US public for a return to Glass-Steagall. But big banks are resisting; they have committed too many resources to the investment side of their businesses to be willing to accept any material change in prevailing law. Just this week, Bank America announced that it will fully absorb its Merrill Lynch unit; it seems there is no turning back now.
All this can make one nostalgic for the simpler days of Glass-Steagall, when banks and brokers stuck to their own specialties and did not look for trouble outside their own lines of business. But perhaps a new, updated form of Glass-Steagall can have a place in today’s integrated global financial system. The anything-goes system we have now seems far from ideal. More on this subject to follow.
Below is a chart of Bank America stock: Has the Financial Supermarket model worked?