Bring Back Glass-Steagall?
By Robert Buzzanco
Mr. Buzzanco is Professor and Chairman, Department of History, University of Houston. He is the author of Masters of War: Military Dissent and Politics in the Vietnam Era and Vietnam and the Transformation of American Life, and numerous other publications on foreign policy and political economy.
Yes, as through this world I've rambled
I've seen lots of funny men;
Some will rob you with a six-gun,
And some with a fountain pen.
IN 1933, AMID THE depths of the Great Depression, Senator Carter Glass of Virginia and Representative Henry Bascom Steagall of Alabama crafted a law to separate commercial and investment banking, the Glass-Steagall Act. In most ways, Glass and Steagall were typical Democrats: ardent segregationists with a populist bent for poor whites, but also connected to monied interests and deeply motivated to save the financial system that had fallen apart a few years earlier.
In 1999, led by Senator Phil Gramm of Texas, another southerner but without the populist politics, and one of the best friends American bankers ever had, congress overwhelmingly repealed the Glass-Steagall Act and created the financial free-for-all that has led banks to offer, along with savings and checking accounts, securities, stock sales, and insurance. The repeal of Glass-Steagall, it is not an overstatement to suggest, has been a principal reason for the financial crises that have fallen upon the United States today, and shows the deep dangers of deregulation.
One of the principal causes of the Wall Street Crash and Depression of the 1920s and 1930s was irresponsible banking activity. Due to a massive expansion of the economy in the years after World War I, the corporate and financial class found itself with vast sums of surplus capital--money that was not being invested for productive purposes. Looking for ways to get more return on that capital, these men turned to financial speculation. At that time, there was no separation between commercial banking like offering bank accounts or home loans to local communities, or investment banking like selling securities or stocks.
With a new flood of money coming their way in the early- and mid-1920s, commercial banks themselves became more speculative, investing heavily in the stock market, often without adequate reserves, and buying new issues of capital for resale to the public. Banks would also issue excess loans, often unsound, to the companies in which they had invested, and then advise their clients to invest in those same stocks. The result of this financial shell game, not surprisingly, was the 1929 crash of the entire U.S. and much of the global economy. Glass-Steagall's purpose was to create a regulatory barrier between the commercial and investment banking sectors, to assure consumers that their money was safe (the Federal Deposit Insurance Corporation was also part of the law), and to prevent bankers from using commercial paper to speculate wildly on stocks-in short, to abet Franklin Roosevelt’s efforts to save capitalism.
Twenty-three years later, in 1956, congress took the additional step, in the Bank Holding Company Act, of separating the banking and insurance industries by preventing banks from underwriting insurance.
Both of these regulatory acts, it is important to note, had significant support among certain key sectors of the banking community, especially bigger Wall Street banks and those with transnational interests (as promoted in the Webb-Pomerene and Edge Acts of 1918-1919), that realized that government regulation was necessary to protect larger and more responsible banks from those which speculated wildly in the securities, stock, and insurance industries. (Glass, in fact, had helped create the Federal Reserve System in 1913).
Regulation, as was often the case, far from being an anti-banking measure, and cloaked in the rhetoric of helping consumers, in fact brought stability to the banking industry, and in particular the largest Wall Street firms which used such measures to gain greater shares in the industry and drive out smaller and more speculative competitors.
By the late 1990s, with the stock market surging to unimaginable heights, large banks merging with and swallowing up smaller banks, and a huge increase in banks having transnational branches, Wall Street and its many friends in congress wanted to eliminate the regulations that had been intended to protect investors and stabilize the financial system. Hence the Gramm-Leach-Bliley Act of 1999 repealed key parts of Glass-Steagall and the Bank Holding Act and allowed commercial and investment banks to merge, to offer home mortgage loans, sell securities and stocks, and offer insurance.
A financial bazaar had been opened, and financial giants like Goldman Sachs, whose previous head, Robert Rubin, was the Treasury Secretary at the time and whose CEO was current Treasury Secretary Henry Paulson, and Citigroup began to gobble up brokerage firms like Smith Barney, Paine Webber, Salomon Brothers, Merrill Lynch, and others. Globally, such deregulation and privatization of markets also led to economic calamities in Chile’s Social Security system and the Asian currency crisis of the late 1990s. Here in Houston, I began to notice on seemingly every block a new bank being built, particularly Washington Mutual and Comerica. Something was clearly afoot.
This new banking system has marked the final phase in the "financialization" of the U.S. and world economy, an evolution in which commodity production and trade has been replaced as the dominant economy activity by the actions of financial markets, which has brought with it huge debt--both public and consumer--and massive deficits in relation to the central banks of Europe and Asia-and China in particular, which now holds nearly 1.5 trillion U.S. dollars. Indeed, there seems to be evidence that foreign creditors such as Saudi Arabia and the Asian central banks have lobbied vigorously for the current bailout plan.
The repeal of Glass-Steagall specifically, and the orgy of financial deregulation more generally, has created the subprime mortgage, banking, and stock market crises of 2008 today, and may very well create an upheaval in the insurance industry shortly. Deregulation, under the guise of celebrating the "free" market, not only damaged consumers, but caused disarray in the industries that it was intended to help--banking, securities, stocks, insurance--by allowing for renewed speculation, unsound mergers, and irresponsible lending.
The problem today is probably too large for a new version of Glass-Steagall to fix it. The global financial system–with derivatives, hedge funds, collateralized debt, and other such economic alchemy has moved far beyond the days of commercial and investment banking. But it should be absolutely clear that the government has to have a much-increased role in regulating banks and securities firms, and in the economy as a whole.
Many, such as Senator John McCain and ex-Senator Gramm, his chief financial advisor, have boasted of being "deregulators" and have complained that government rules on the financial sector have actually damaged the market by limiting economic activity. The Clinton Administration believed, and acted, likewise. In truth, those regulations, today as much as in the 1930s, were meant to stabilize the system and protect the banking and corporate class, often against themselves [one of Herbert Hoover's favorite quotes was "the problem with capitalism is the capitalists-they're too damned greedy," and he generally, and unsuccessfully, supported banking regulation as Commerce Secretary].
Banking regulations must be reinstituted as a first measure to address the current crisis. Bailouts without reform are merely multi-billion dollar welfare checks to those who need them the least. In fact, American International Group has already used $61 billion of its $85 billion taxpayer bailout, mostly to stop the bleeding in its structured finance unit and securities lending business, and the company’s debt has already been downgraded by Moody’s. Due to changes in oversight rules by the Securities and Exchange Commission, the leverage ratio of the biggest banks, the measure of a firm’s debt compared to total assets, has risen to 30:1 or more in many cases, where it used to be in the 15-20:1 range. In the past week A.I.G. asked for another $38 billion.
In the 1930s, Glass and Steagall believed that the government had to step in to rescue the banking system in its darkest hours, but the New Deal did incorporate such “top down reform” with some benefits for the working classes and the poor. Unfortunately, the attack on public institutions has become overwhelming and the private enterprise system (there’s nothing “free” about it) so entrenched that the problems we face today are more acute and the need for control of the banking system more urgent than ever. Glass and Steagall had it right in the 1930s and some updated version of that needs to reappear today. No other institution exists with the clout or the ability to coerce financial institutions but the state, and its ability to do so has been so diminished in the past quarter-century (and its will even more so) that any actions taken by government, such as the recent bailout, are not likely to restructure the economy in any meaningful way.
Still, working people’s pensions, not to mention jobs and wages and savings and checking accounts, are at stake, and something has to be done. Bring back Glass-Steagall, updated for modern times, and from there reawaken the spirit of Upton Sinclair and Huey Long. Our times are becoming so desperate, it just might work.
And as through your life you travel,
Yes, as through your life you roam,
You won't never see an outlaw
Drive a family from their home.