On Thursday, Sen. Elizabeth Warren (D-Mass.) along with three other senators proposed a bill that would reinstate key elements of the 1930s-era Glass-Steagall Act, or the 1933 Banking Act.
Warren, John McCain (R-Ariz.), Maria Cantwell (D-Wash.), and Angus Kin (I-Maine) introduced legislation that would again separate bank's traditional activities (like deposits currently backed by the Federal Deposit Insurance Corp.) from riskier activities like investment banking, insurance underwriting, swap dealing, and hedge funds.
Glass-Steagall was repealed by Congress back in 1999.
When the news broke of Warren’s determined attempt to bring back Glass-Steagall last week, it covered front pages across the country and instigated a firestorm of commentary on the future of the U.S. economy.
The problem, of course, is the ability to cut through the hype and understand if financial reform is necessary to fix the U.S. economy.
Rarely do I find myself championing regulatory efforts by the Federal Government, but the financial sector is an entirely different beast from energy, agriculture, and other resource sectors.
But reinstituting key elements of the Glass-Steagall Act is just one step on a long return to sanity for the economy.
The End of Too Big to Fail
In 2008, as the financial crisis unfolded, many in Washington wanted to reduce the size of the banks, because they had grown too large and were considered "Too Big to Fail." The government was about to throw billions of dollars into the bailout of the Big Banks.
But during the financial crisis, in order to stave off more bankruptcies, the Treasury Department actually made it easier for banks to grow even larger in a swath of mergers and acquisitions that led to a staggering concentration of wealth among the largest banks in the country.
"The four biggest banks are now 30% larger than they were just five years ago and they have continued to engage in dangerous, high-risk practices," Warren said during a Senate Banking Committee hearing.
Meanwhile, attempts to curb Wall Street excess in 2010 with the Dodd-Frank Bill did little to clean up the system.
In the end, Americans ended up with a piece of toothless regulation. The law was quickly watered down by remarkable lobbying efforts by the financial sector, including an unprecedented effort to limit even the Volcker Rule, which aimed to curb proprietary speculation.
Now, Warren and her colleagues are aiming to create the 21st Century Act. According to our Shah Gilani, this new proposal would "would separate institutions with savings and checking accounts, in other words FDIC-insured depository commercial banks, from investment and trading 'banks' engaged in capital markets activities, most of which are on the border between speculation and manipulation."
Here Come the Lobbyists
The reaction from Wall Street is predictable. The banks will say that increasing regulation on their activities will help facilitate another financial crisis.
Of course, this was also predicted by the banks in 1997 when regulators proposed overseeing the derivatives markets. After they lobbied to kill any regulation, 10 years later these toxic assets facilitated a major crash.
Instead, we should have listened to those who opposed the repeal of Glass-Steagall, because they too predicted a financial crisis would eventually result because of this deregulation.
At the time of its repeal, opponents of repeal argued that unshackling financial companies from regulations would enable them to shift their focus into unchartered areas of banking activity. As a result, these critics said, economic crisis was not just possible, it seemed inevitable.
Perhaps the most chilling prediction came from former Senator Byron L. Dorgan, Democrat of North Dakota just two days after the repeal of Glass-Steagall.
"I think we will look back in 10 years' time and say we should not have done this but we did because we forgot the lessons of the past, and that that which is true in the 1930's is true in 2010," Dorgan said.
"I wasn't around during the 1930's or the debate over Glass-Steagall<" he added. " But I was here in the early 1980's when it was decided to allow the expansion of savings and loans. We have now decided in the name of modernization to forget the lessons of the past, of safety and of soundness.''
For many, this statement is a chilling reminder of how vulnerable the U.S. economy had become by deregulation of the banking sector in the late 1990s.
Just a Starting Point
Our Shah Gilani isn't entirely optimistic that the law or reform will be passed. He cites the obvious problem in Washington that would essentially make it impossible to fix: Lobbying.
Wrote Shah: "The only problem with trying to make banking 21st century safe is that we live in the new old age of robber barons, and they are the bankers and politicians they've bought."
But the another important aspect of the conversation is that other types are reform would be needed as well.
Real financial reform requires more than just reducing the size of the banks and limiting their commercial and investment activities. Canada, for example, had only a mild economic downturn despite having a highly concentrated banking sector.
It also requires the willingness to address other factors that played a key role in the financial crisis and were essentially ignored or gutted from the Dodd-Frank Act of 2010 after extensive lobbying efforts and threats that the sky was falling.
Perhaps it isn't the size of the banks that matters, but instead the types of securities that banks are allowed to invest in and the amount of leverage they may possess.
Congress seems to be overlooking the fact that it was massive derivative positions that led to this crisis, acting like weapons of financial mass destruction. But Congress also must recognize that banks were allowed to return to pre-Depression levels of leverage in 2004.
While Warren is getting the spotlight, a more important matter is happening in the Senate. Two Senators are looking to pass legislation to reduce leverage and increase capital-holding requirements.
Sens. Sherrod Brown, D-Ohio and David Vitter, R-La., recently introduced a bill that would force "Too Big to Fail" institutions to hold more capital, thus reducing leverage and protecting against significant losses.
This will be a very hard fought battle with a lot of misinformation being spread about the impact that such regulation would have on the economy. Stay tuned, as we continue to weed through the lies in order to deliver the truth on what reform in Washington would really mean to Wall Street.
About the Author
Garrett Baldwin is a globally recognized research economist, financial writer, and consultant with degrees from Northwestern, Johns Hopkins, Purdue, and Indiana University. He is a seasoned financial and political risk analyst, with a focus on stocks, hedge funds, private equity, blockchain, and housing policy. He has conducted risk assessment projects for clients in 27 countries, and consulted on policy and financial operations for some of the nation's largest financial institutions, including a $1.5 trillion credit fund, a $43 billion credit and auto loan giant, as well as two of the largest Wall Street banks by assets under management.
Garrett joined Money Map Press as an economist and researcher in 2011, specializing in alternative strategies with an emphasis on fundamental and technical analysis.