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Avoid bailouts: Restore Glass-Steagall
Robert Reich
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TEXT OF COMMENTARY
Kai Ryssdal: We spent some time up at the top of the broadcast today talking about the financial crisis next time. What Washington is doing to try to stop something like the last 18 months from ever happening again. Commentator Robert Reich suggests the best new rule for Wall Street is actually an old one.
ROBERT REICH: The five biggest Wall Street banks are even bigger now than they were before the Great Meltdown. Together they hold over 40 percent of U.S. deposits. And they're raking in huge profits and paying fat salaries and bonuses as if nothing happened.
The only difference is, now they know they're too big to fail so the government will bail them out if they get into trouble. And like a giant, gawking adolescent who's just discovered he can crash the convertible his rich dad gave him and the next morning have a new one waiting in his driveway, the big banks will drive even faster and take on even bigger risks.
Almost no one in Washington wants another bailout, but there are two very different ideas for how to avoid it. The administration would put any giant bank that's in danger of failing into a so-called "resolution" process akin to bankruptcy where the bank's assets would be sold off to pay its creditors.
But that's no answer. By the time a really big bank gets into trouble -- one that poses a "systemic risk" to the entire economy -- it's too late. Other big banks, competing like mad for the same talent and profits, will already have adopted many of the same risky techniques. And the pending failure will already have rocked the entire financial sector.
A better idea is to restore the Glass-Steagall Act, which until 1999 separated investment from commercial banking. No public interest has been served by allowing the casino called investment banking to merge with the traditional intermediary function linking savers to borrowers. In fact, it's caused nothing but trouble.
Separate them, and investment banks would not be too big to fail because they couldn't use commercial deposits, insured by the FDIC, to place big investment bets. Separate them and mortgage lenders couldn't re-sell mortgage debt as securities -- they'd have to bear responsibility for defaults, which would give them an incentive to carefully investigate credit risks before making a loan. Re-enact Glass-Steagall. Not exactly a rallying cry, but it should be.
RYSSDAL: Robert Reich is a professor of public policy at the University of California.
Has Robert Reich ever done anything other than work for government? Those investment banks (e.g. Goldman Sachs) that were separate from consumer banks teetered like the those that were coupled together AND regulators moved them to take customer deposits to avoid collapsing. Now RR wants us to undo what the government just thought was the right answer? Why does Marketplace continue to broadcast this man's opinion?
Did the big 5 investment banks actually have FDIC insured deposits in the period leading up to the crisis? I don't think they did, that was something that happened in the aftermath. And weren't they already "Stand alone" investment banks, just as GS would have dictated? If so, what difference would GS have made? This strikes me as just more fact-free bloviation; from Marketplace's favorite fact-free bloviator.
I am not a banker and still after listening to RR, it is clear his reasoning behind reinstating GS is flawed. 1) Ibanks that got into trouble did not rely on customer deposit to finance their activities and instead used wholesales funding 2) Banks that got into trouble also were using less and less of their customer deposit to finance their lending activities, instead shifted to rely more on wholesale funding also 3) As Richard C points out Fannie and Freddie are favored institutions by Democrats make securities out of loans without relying on deposits and faired no better than the banks or ibanks, haven been fully taken over by government 4) preventing the securitization of loans altogether is likely to mean lower amounts of credit altogether - think of the inability to securitize credit card loans which makes up a quarter of the amount credit card debt 5) not all securitization is bad, credit card securitization is not subprime securitization 6) some of the large firms involved in subprime lending were specialty finance companies, not banks, which are unregulated anyway and therefore would not have been affected by a GS regulation 7) At least 1 large ibank, which has weather the storm better than the rest was not heavily involved in subprime (in fact shorted the market when others were drinking the coolaide) and does not take a lot of customer deposits and is not a bank 8) many banks that are not heavy participants in securities markets are in big trouble because of their heavy exposures to loans that are going bad fast but did not participate in subprime, so GS would have been beneficial to them 9) Does RR really think that raising capital by equity and corporate debt is only a casino (which is the primary realm of ibanks)
While endorsing GS might have merits, RR reasoning is completely flawed in why he comes to this conclusion. it shows a thorough misunderstanding of the US financial system and its complexities. A better set of arguments can be gotten from other, more knowledgeable experts. Plus does he really think you can put the genie bank in the bottle that solution would just mean that banks would place large operations in offshore centers outside of US jurisdiction or some other entity would be created to circumvent these rules.
Mr. Reich's arrogance is only surpassed by his ignorance.
If Glass-Steagall is the solution, why was there the problem of Too Big To Fail before the Financial Services Modernization Act (which dismantled Glass-Steagall)? Why did foreign universal banks, which did not have the artificial separation of investment banking, commercial banking, and insurance not get to the point of being Too Big To Fail?
Maybe the problem isn't that we need more regulation--since, who says the regulators know better than anyone else--maybe we need better regulation. Maybe we need the government to adopt a policy of Too Big, Oh Well. Systemic risk arises when the government makes it arise by convincing people that there is a problem and the only solution is to bail out those who should fail. Too Big To Fail? Who says? Run the experiment! Let them fail.
I heartily endorse Prof. Reich's call to reinstate the Glass-Steagall Act. Retaining the name in a re-enactment would allow the "regular citizen's of our great land" to inculcate financial acumen at a tender age. Consider this scene from 2025:
Dad: Pop up on my lap, now sweetie, I want to give you your weekly allowance. But first lets review our lessons.
Child: Ok, Daddy!
Dad: Now, what is the name of the Act?
Child: Glass-Steagall.
Dad: VERY GOOD sweetie! Now, the full name?
Child: The Glass-Steagall Act of 1933 & 2010.
Dad: VERY good. I'm proud of you! Ok, one more question! What do you do when you hear it has been repealed?
Child: I retire all my debts. Ah...I sell all my possessions...and...and...I buy gold!
Dad: THAT'S RIGHT! Sweetie, I'm very happy and proud of you! Here's your weekly $50.
Child: Oh BOY! Now I've finally saved enough for the large-size lollipop!!
Dad: Well we could double that to $100 a week if you learn some more financial phrases.
Child: Like what?
Dad: Well, we could start with "invidious investment banker" or "reprobate central banker".
Child: Retrobake senile banker?
Dad: We'll work in it sweetie.
I agree with Mr. Riech. It is a simple and easy fix.
I'm with Ameriprise Financial, formerly with PaineWebber then UBS, and was always against it's repeal. The purpose of Glass-Stegal was akin to water tight bulkheads in a ship in order to control flooding. The brain trust that removed the bulkheads need to brought to task.
I do have to point out that Mr. Riech was part of the Clinton Admin that was responsible for the repeal of Glass-Stegal. What was his stance then?
Regards,
Raymond Bourque
Senior Financial Advisor
Account Vice President
813-289-000
Ps they could also regulate the commodity markets again.
Works for me!
And while we’re at it, change the FDIC deposit insurance formula. The bigger the bank, he higher the risk and hence the higher the rate.
But I am somewhat puzzled – banks were selling off mortgages long before Glass-Steagall was repealed. A big part of the 2004-2008 bubble, and the costs to us taxpayers, was that “Fannie Mae†and “Freddie Mac†pretty much had to buy any mortgage the commercial lenders brought to them.
