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Question: Please address why the removal of the Glass-Steagall Act in 1999 caused the financial meltdown of 2007 and why its reinstatement is the only way to stop the financially risky behavior allowed after it's removal. Address why we will very likely have another meltdown (probably in 2010) unless reinstated.
Answer: Mr. Scott: While the overturning of what remained of Glass-Steagall did not cause the meltdown, it certainly contributed mightily to the systemic nature of the crisis.
Allowing commercial banks and investment banks to marry created giant operations that became too big to fail and too profitable to break up. Everyone was making money. The overriding problem was not the integration of commercial (deposit-taking and loan-making) banks with investment (capital-markets trading) banks, but the extraordinary migration of all banks into the same products, trading, and risk-taking businesses. I am definitely including the ubiquitous game of mortgage origination, securitization, sales and trading.
Answer: Mr. Scott: While the overturning of what remained of Glass-Steagall did not cause the meltdown, it certainly contributed mightily to the systemic nature of the crisis.
Allowing commercial banks and investment banks to marry created giant operations that became too big to fail and too profitable to break up. Everyone was making money. The overriding problem was not the integration of commercial (deposit-taking and loan-making) banks with investment (capital-markets trading) banks, but the extraordinary migration of all banks into the same products, trading, and risk-taking businesses. I am definitely including the ubiquitous game of mortgage origination, securitization, sales and trading.
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While it would seem prudent to separate taxpayer-backstopped commercial banks from investment-banking operations that take more risk, it's not likely to happen.
Too many interested parties have too much money to arm lobbyists to maintain Wall Street's status quo.
The so-called "Volcker Plan" to ban "proprietary trading" at institutions that take depositor funds and that are ultimately backstopped both by the Federal Deposit Insurance Corp. (FDIC) and taxpayers is a sensible plan. It has been reviled on the grounds that it is unworkable because it is impossible to define "prop" trading.
But that's just a ruse. The real reason the plan is hated is because it represents a back-door resurrection of Glass-Steagall. In order to stop prop trading at deposit-taking banks, we'd first have to separate deposit-taking banks from investment banks with trading and broker-dealer operations.
Too bad the plan has already been flattened by a frontal assault from U.S. senators Christopher J. Dodd, D-CT., and Richard Shelby, R-Ala., U.S. Rep. Barney Frank, D-Mass., and the rest of the Wall Street shills.
But the Volcker plan makes sense. The truth about proprietary trading is that it needs to be defined narrowly. If a deposit-taking institution holds risky securities or products that it intends to profit from, that's a form of trading - there's a risk involved. Not that there aren't risks involved in a bank making loans that don't get repaid. That is also a bank risk - but at least that's a risk that can be better-managed, accounted for, and provisioned for.
Banks shouldn't take inordinate risks for profit and derive executive compensation from risky trades made with taxpayer protection. That's a recipe for moral hazard on a massive scale.
If we're going to prevent another meltdown, the first thing we have to do is make sure systemic integration doesn't create another supra-trade like we saw with the subprime trade that wrecked so many banks and households.
We need to break up big banks so that they can never again endanger the functioning of capital markets or the economy. We also need to create a logarithmic capital-ratio-scaling regime to ensure that as risk increases, capital is more than plentiful to absorb losses.
[Editor's Note: Retired hedge-fund manager R. Shah Gilani has established a reputation as one of the leading experts on the global credit crisis. His savvy analyses have appeared in Money Morning and have been read by millions across the Internet. In a special report that appeared last week, Money Morning Contributing Editor Shah Gilani detailed the need to ban risky trading by banks. To check out that report, please click here.]
News and Related Story Links:
Too many interested parties have too much money to arm lobbyists to maintain Wall Street's status quo.
The so-called "Volcker Plan" to ban "proprietary trading" at institutions that take depositor funds and that are ultimately backstopped both by the Federal Deposit Insurance Corp. (FDIC) and taxpayers is a sensible plan. It has been reviled on the grounds that it is unworkable because it is impossible to define "prop" trading.
But that's just a ruse. The real reason the plan is hated is because it represents a back-door resurrection of Glass-Steagall. In order to stop prop trading at deposit-taking banks, we'd first have to separate deposit-taking banks from investment banks with trading and broker-dealer operations.
Too bad the plan has already been flattened by a frontal assault from U.S. senators Christopher J. Dodd, D-CT., and Richard Shelby, R-Ala., U.S. Rep. Barney Frank, D-Mass., and the rest of the Wall Street shills.
But the Volcker plan makes sense. The truth about proprietary trading is that it needs to be defined narrowly. If a deposit-taking institution holds risky securities or products that it intends to profit from, that's a form of trading - there's a risk involved. Not that there aren't risks involved in a bank making loans that don't get repaid. That is also a bank risk - but at least that's a risk that can be better-managed, accounted for, and provisioned for.
Banks shouldn't take inordinate risks for profit and derive executive compensation from risky trades made with taxpayer protection. That's a recipe for moral hazard on a massive scale.
If we're going to prevent another meltdown, the first thing we have to do is make sure systemic integration doesn't create another supra-trade like we saw with the subprime trade that wrecked so many banks and households.
We need to break up big banks so that they can never again endanger the functioning of capital markets or the economy. We also need to create a logarithmic capital-ratio-scaling regime to ensure that as risk increases, capital is more than plentiful to absorb losses.
[Editor's Note: Retired hedge-fund manager R. Shah Gilani has established a reputation as one of the leading experts on the global credit crisis. His savvy analyses have appeared in Money Morning and have been read by millions across the Internet. In a special report that appeared last week, Money Morning Contributing Editor Shah Gilani detailed the need to ban risky trading by banks. To check out that report, please click here.]
News and Related Story Links:
- Money Morning Mailbag:
The High Cost of Greed ...
- Wikipedia:
The Glass-Steagall Act
- Money Morning Special Report:
It's Time For "Banks" to Stop High-Risk Trading
- Wikipedia:
Proprietary Trading
- Money Morning Special Report:
Wall Street's Stranglehold on the Economy Is Choking Americans
- PBS Frontline:
The Long Demise of Glass-Steagall
- FDIC.gov:
Official Web Site
- Wikipedia:
Too Big To Fail
- Investopedia:
What Was Glass-Steagall?
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Tags: Banking, Credit Crisis, FDIC, Glass-Steagall Act, Proprietary Trading, Too Big to Fail, Volcker Plan
In my thinking the only thing that helps to prevent our communities of the risktaking activities by banks is to tell them now, that how large of how small they are, there will never come one more penny to rescue them.
Risktaking is OK, but the profits and the losses are for them and for no one else.
Banks are no public utilities.
I truly agree with you. The Glass-Steagall act needs to be reinstated. However, that will never happen as long as special interest groups continue to fund our government (politicians). It will only be through the will of the people that any change will take hold. Any it is my belief that politicians are running scared, fore they may see the writing on the wall, that if they don't do something to correct the direction of this country, recover the trust of the people and start to listen to the people of this great country they will have a huge fight on their hands. The public is tired of the gross misjustices carried out by our politicians in local, state and federal government and there is only so far you can push before the people push back.
I totally agree with Steve R and with Mr Gilani. It's oh so apparent that what we have now is a government of the corporations, by the corporations, and for the corporations. Individual peoples' will doesn't count for much right now.
Dear Mr. Gilani,
Thank you for responding to my question regarding The Glass-Steagal Act of 1934. After watching the Congressional testimony last week I found myself coming to the same conclusion that most of the Congress has given in to the lobbiests donations or refuse to understand the incredable financial danger that has developed since the removal of Glass-Steagall. One has only to remember that it was the Crash of 1929 and the Great Depression which brought the Pecore hearings which in turn resulted in the crafting of the Glass Steagall Act. That worked well for about 70 years. In my opinion, this reads like a review of the Kondotiev Wave in that the ultra rich and powerful have, once again, taken over, removed regulation, and in the process, once again, blow up our financial system. I fear that we are about to watch history repeat itself, and that only after another bigger crash, when the public is crying for blood, will we see the Glass-Steagall Act, or the same thing under another name, reistablished. Again, thank you for your indepth response. I must say, that I feel anger and frustration, that we are about to witness one of the greatest financial meltdowns of the past 80 years and there appears to be little we can say or do which will stop it from happening.
For those readers not familiar with how Glass Steagall went away, I'd suggest they Google: "Mr. Weill Goes To Washington" by Bill Moyers of PBS. This article was written in 2000 and, in my opinion, was very prophetic in forecasting the meltdown of 2007, and , in my opinion, an even greater meltdown coming in the near future.
Respectfully,
Mike Scott
i totaly agree , we are no a trip to i dont know wear and no one seames to care but gold is the thing to buy. ps. my computer will not open pdf,s please replye in regular letters thank you
tom
Dear Mr. Scott:
Thanks for your note. By the way, apparently the interchange between you and Shah was considered to be so strong that CBS MoneyWatch posted a link to our "Money Morning Mailbag" piece on their Web Site. Here's the link, if you'd care to take a look.
http://finance.bnet.com/bnet/news/category?Category=credit
Thanks again for your time and for your excellent question. Please feel free to drop us a line again.
William Patalon III
Executive Editor
Money Morning
Dear Readers:
These are all excellent observations and analyses of the challenges facing the U.S. financial system. Please feel free to continue your submissions; reader involvement like this is a big part of why Money Morning is emering as one of the top finance and investing sites on the Web. That should be no surprise, given that we have some of the best-informed readers anywhere…..
Thank you again;
William Patalon III
Executive Editor
Money Morning
I see TWO separate and distinct problems with our current financial systems. First one is well described in this article by Shah Gilani i.e. the marriage of commercial banking and investment banking has simply resulted in openly abusive practices.
This however is only half the problem. What has transpired in the last decade is yet another but covert abusive practice – that of the collusion of the investment bankers and the corporate CEOs. Investment bankers routinely meet with corporate CEOs and have devised multiple ways to mutually fill their personal pockets. Some of these practices are to create short-term profitability (cutting costs, moving jobs overseas etc…) to ‘pump and dump’ stocks. Many otherwise legitimate companies have been caught into this trap and now either no longer exist or barely survived after the wrath of the investment bankers and the corporate CEOs (who by the way took-off with millions from these legitimate institutions). Examples that come to mind are MCI/Worldcom, Qwest, Tyco, Nortel, Enron…etc… and the list goes on and on….
This second problem is worse for our economic system as it has resulted in:
1. lack of innovation (bound to happen as companies are thinking short-term profitability)
2. lack of customer service (reduce staff and send customers to voice prompter systems, company web sites…etc…. so let the customer waste time to do the research instead of a company representative answering the customer question)
3. lack of employment (sending jobs overseas to low-wage countries)
4. siphoning-off of vast amounts of money from the middle class (redirecting money to pay massive bonuses for investment bankers and company executives)
5. moral decline as lobbyists of these crooks have bought-out our congress and even our judges
There is an urgent need to bring about a correction to BOTH of these problems. One correction without the other isn’t going to work and there is an immediate need to address both problems. Until this correction is accomplished by our current administration, I don’t see an end to our economic problems. We simply have no choice but to support their efforts and let the lobbyists know that the people are fed up with the crooked ways of the investment bankers and some of these corporate CEOs!
Mr Halpin writes: " … what we have now is a government of the corporations, by the corporations, and for the corporations."
Yes, indeed. According to Mussolini's Party who invented the term, this is the very definition of "fascismo."
Add the highest U.S. courts now allowing corporations to finance their own candidates, and it looks scarily like the beginning of the end.
Mr Gilani's insights are brilliant but I think we are doomed. "We the People" has been scrapped in favor of "We the Corporations" and may not be set right other than during a heartbreaking depression. Sad. Very sad.
Uh, this article is nothing more than an assertion. Do you have any data on Glass-Steagall's contribution? If we hadn't bailed out the banks afterwards, would your assertion still hold?
How would BofA bailed out Merrill without the repeal? How did the behavior of AIG and Bear Sterns get worse because of the repeal? How about Fannie Mae and Freddie Mac? Moody's and the other credit agencies? And what of the contribution of the Fed policies, or of forced lending relaxation and subsidized borrowing.
I just don't get the connection. Correlation is not causation. But provide some data on Glass-Steagall's role and maybe I'll buy it.
Mr. Kilmartin,
I'd suggest that you read Mr. Bill Moyers article from 2000 in Frontline on PBS.. Personally, I think he should get a Pulitzer for it! It contains a very good, short history of the findings of that period and the Pecore hearings which shined a very bright light on the how, when and why relating to the Crash of 1929 and the ensuing Great Depression. Perhaps that will impress you. It is my opinion that there are a lot of parrallels between 1921-1929 and 1999-2010 and they all revolve around The Glass-Steagall Act.
Mike Scott
Well, I looked for the article in question, and all I found was a story about JP Morgan and a midget. Didn't see a high ROI in reading that.
Is your position that:
1. If we had Glass-Steagall back, the meltdown doesn't occur?
2. If we had Glass-Steagall before the 1929 crash, then the crash and/OR the depression doesn't occur?
3. All the other regulations and regulatory bodies passed during the new deal (e.g. FDIC, SEC) helped the depression recover quickly and prevent other recessions / downturns?
Hopefully by now, you can see the sarcasm. The meltdowns which occur are a natural consequence of the boom which preceded it. Booms are created by misallocation of resources.
The primary misallocation of resources was overpricing real estate, fueled by government policies and agencies trying to expand home ownership and cheap fiat currency.
That is not to say that those who placed extra large leveraged bets shouldn't have done that. No amount of hind sight regulation is going to prevent that from having happened. The right thing to do was to let those institutions fail. Instead, they were rewarded with bailouts.
Government elitists cannot determine how the world's assets should be priced. They can screw it up, though, and they always do.
That being said, if you supply me with the exact reference, I'll be glad to consider reading the data on Glass-Steagall. But as long as we're recommending reading material, I'd recommend both Norberg's "Financial Fiasco" and Sowell's "Housing Boom and Bust". Less strongly, I'd recommend Folsom's "New Deal or Raw Deal".
Google: "The Long Demise Of The Glass Steagall Act" and "Mr. Weill goes to Washington". Both where done by Frontline of PBS in about May of 2003. I hope these answer your questions. Sorry, the above date was wrong. Few paid any attention when these pieces where written, then came November 2007….. Thank you for your reading suggestions.
Mr. Kilmartin you raise several interesting points. I would suggest anybody would be hard presses to present data to show how the Glass-Steagall act would have prevented or at least exacerbated our most current meltdown. The only way to present that data woud have been to have the laws in effect presenting the data how market manipulators worked their way around the law.
Suffice it to say the Glass-Steagall act was definitely considered a hindrance otherwise the Gramm-Leach-Bliley Act and the Commodity Futures Modernization Act of 2000 would have never been born.
Those to Act's alone are proof enough to show how bought off American politicians are today. It's really a disgrace.