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Glass-Steagall Returns

Anyone who has studied the financial crisis knows that Glass-Steagall wouldn’t have prevented it. Glass-Steagall was the law that required commercial banks and investment banks to be separate businesses. Basically, investment banks couldn’t gamble with commercial bank deposits. In 1998, Bill Clinton signed the repeal of the law and investment banks began merging with their commercial counterparts.

Except the banks that failed during the financial crisis weren’t combo investment and commercial banks. Lehman Brothers and Bear Stearns were both investment banks. AIG was an insurance company. Countrywide and Washington Mutual were just commercial banks. Undoubtedly, having Glass-Steagall in place would have lessened the damage of the crisis slightly, but it wouldn’t have come close to prevent it.

Now, Senators Elizabeth Warren (D-MA) and John McCain (R-AZ) are out with a bipartisan bill that would reinstate the law. Kevin Drum isn’t impressed:

I’m in favor of smaller banks, and I suppose that splitting up the big universal banks would accomplish that. But either Congress is willing to split up the big banks or it isn’t. If it’s not, then McCain-Warren bill won’t pass. It it is, there are far better ways of doing it.

For my money, I wouldn’t bother at this point. I’d simply mandate higher capital requirements for everyone, and much higher capital requirements for the biggest banks on a sliding scale. That would automatically put pressure on banks to stay smaller, and it would make them safer regardless of their size. It’s a better, simpler way to go.

I think Drum is missing an important point here: reinstating Glass-Steagall has greater name recognition than any other bills. Americans hated the bank bailouts. They still dislike the banks and a number of Congressmen still are concerned with Too Big To Fail. There actually is motivation from both sides to enact a law that would restrict the size of major banks. No legislation is close to passing and bank lobbyists will flood with the capital with both money and threats if anything appears close to passing. But if Congress is going to find a way to pass something, Glass-Steagall is its best shot. That’s for two reasons:

There is public support for reinstituting Glass-Steagall.

There is public support for reinstituting Glass-Steagall.

1. People have heard of Glass-Steagall. They may not know much about it, but lots of people have vaguely heard the name. They may remember that banks were overjoyed went it was repealed in the late 1990s. They may remember some analysts (wrongly) arguing that Glass-Steagall could have prevented the crisis. It’s not a large mass of people, but it’s a larger group of people than will have heard of any other potential law. Senators Sherrod Brown (D-OH) and David Vitter (R-LA) have also authored a bill designed to combat TBTF – mostly by ramping up capital requirements (as Drum wants). But which potential bill do you think will have greater name recognition? Which would people support more?

2. Intuitively, Glass-Steagall makes sense. Explaining capital requirement is not easy as Matt Yglesias noted earlier this week. But telling banks that they can’t gamble with the money you deposited? Well, that just seems like a no brainer. Congressmen will find it much easier to explain to their constituents the reinstitution of Glass-Steagall than a new law. Banks are going to be up in arms no matter what. A straightforward, simple explanation to voters would help both Democrats and Republicans find the political cover to go against the big banks. Glass-Steagall offers that.

Now, Glass-Steagall isn’t the best way to break up the banks. And it shouldn’t be looked at as a fix to the financial crisis – as noted above, the repeal of Glass-Steagall did not cause the crisis. But it’s the bill with the greatest chance of passing Congress that reduces bank risk and makes the financial system safer. That’s worth doing.

So, I disagree with Drum. I don’t think it is as simple as “either Congress is willing to split up the big banks or it isn’t.” For any two obscure, complicated bills, that would be the case. But Glass-Steagall has two things going for it that others don’t and we would be foolish to throw away those advantages for a slightly better, but ultimately doomed bill.

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