"The decision to repeal the Glass-Steagall Act of 1933 provoked dire warnings from a handful of dissenters that the deregulation of Wall Street would someday wreak havoc on the nation's financial system. The original idea behind Glass-Steagall was that separation between bankers and brokers would reduce the potential conflicts of interest that were thought to have contributed to the speculative stock frenzy before the Depression."
Being right is tough, especially when you're not vindicated until years later (and after years of "success" by the new policies).
More:
"''Scores of banks failed in the Great Depression as a result of unsound banking practices, and their failure only deepened the crisis,'' Mr. Wellstone said. ''Glass-Steagall was intended to protect our financial system by insulating commercial banking from other forms of risk. It was one of several stabilizers designed to keep a similar tragedy from recurring. Now Congress is about to repeal that economic stabilizer without putting any comparable safeguard in its place.''
Supporters of the legislation rejected those arguments. They responded that historians and economists have concluded that the Glass-Steagall Act was not the correct response to the banking crisis because it was the failure of the Federal Reserve in carrying out monetary policy, not speculation in the stock market, that caused the collapse of 11,000 banks. If anything, the supporters said, the new law will give financial companies the ability to diversify and therefore reduce their risks. The new law, they said, will also give regulators new tools to supervise shaky institutions.
''The concerns that we will have a meltdown like 1929 are dramatically overblown,'' said Senator Bob Kerrey, Democrat of Nebraska."
another great quote . . he even got the timing right
''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,'' said Senator Byron L. Dorgan, Democrat of North Dakota. ''I wasn't around during the 1930's or the debate over Glass-Steagall. 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.''
besides the s&l crisis, the long term capital blowup seems to be another good comp in hindsight.
Humans learn best by quick feedback (I think Gladwell had an article about this, can't recall). In complex systems, such as economies, changes can take a long, long time to propagate. Teasing out true cause and effect is pretty much impossible. (Programming large systems can be this way too)
Given this lag time, decision makers never really learn to be experts, since there's no quick feedback.
So Wachovia, instead of being sold to Wells Fargo, should have just went bankrupt? And Merrill Lynch, instead of being bought by Bank of America, should have went bankrupt? That would have eased the crisis, how?
Glass Stegall would have blocked both of those transactions.
Would Glass-Stegall have reduced unprecedented capital flows into the US housing sector from overseas investors and the monetary and fiscal policies of our own government? Because if you still have those capital flows, you still have housing prices going up by 20% per year, you still have lenders lowering their standards, and you still have them getting caught holding the bag.
I'm sorry, I just don't see it.
Not all deregulation is equal. Each individual policy has its own incentives. There are not two undifferentiated piles called "regulation" and "deregulation" that we can add and subtract from. I have a hard time seeing how the repeal of Glass Steagall did anything but mitigate the current crisis.
And yes, during the Great Depression it was small banks that were made artificially small by anti-banking laws that failed. The repeal of anti-size regulation has sound historical reasoning on its side.
Meg McArdle had a good post on this. I need to find out about her background, because she is one of about 5 people on the internet that can write INFORMED analysis of issues like these:
" Even if you ignore the economic history indicating that Glass-Steagall didn't help the crisis it was meant to solve--even if you assume, arguendo, that the repeal was a bad idea--there's simply no logical reason to believe it had anything to do with the current mess.
Securitization was not introduced in the 1990s; it was invented in the 1970s and became popular in the 1980s, as chronicled in Liar's Poker. (As an aside, if you haven't read it, you really must. Especially now).
GLB had nothing to do with either lending standards at commercial banks, or leverage ratios at broker-dealers, the two most plausible candidates for regulatory failure here.
Most importantly, commercial banks are not the main problems. If Glass-Steagall's repeal had meaningfully contributed to this crisis, we should see the failures concentrated among megabanks where speculation put deposits at risk. Instead we see the exact opposite: the failures are among either commercial banks with no significant investment arm (Washington Mutual, Countrywide), or standalone investment banks. It is the diversified financial institutions that are riding to the rescue."
Saying that Bank of America was the only company capable of buying Merrill Lynch is a mistake as is assuming it's sale was a good idea. The goal of regulation is to avoid crisis not to simplify dealing with them once the show up.
PS: Without government intervention BoA buying Merrill Lynch would have destroyed one of the few companies that would otherwise have survived this crisis without any problems.
Wachovia FELL because there was a SILENT run on the bank. More than 5 trillion dollars got taken out of the system which was largely owned by Wachovia.
Look for the day they increased the Fed Savings from $100,000 to $250,000 and you will know the preceding day was the "Silent Run".
''Today Congress voted to update the rules that have governed financial services since the Great Depression and replace them with a system for the 21st century,'' Treasury Secretary Lawrence H. Summers said. ''This historic legislation will better enable American companies to compete in the new economy.''
Yep, the same Lawrence H. Summers who is now Pres. Obama's top financial advisor.
People are complaining that this was a destabilizing bill. And yet, the current crisis is largely due to stabilizers: Fannie and Freddie manipulated mortgage prices to make them trade like treasuries, leading to artificial stability; AIG sold CDSs as part of a regulatory arbitrage, leading to a collapse later on; depositors didn't have any reason to care whether their bank was lending to someone who put 50% down on a first home or 0% down on a no-doc third home -- whatever happened, the FDIC would take care of it!
It is impossible to imagine an alternative history in which a lack of ostensibly stabilizing regulations led to a larger crisis. These rules will tend to reduce the chance of a small disaster, and amplify the effects of a massive one. Thanks to Fannie and Freddie, housing prices couldn't drop 5% in a year -- they could rise 10%, or they could drop by 20%.
If my recollection is correct, when this was happening The Economist magazine was also in favor of it. And one of the reasons they gave was that a more diverse business will make bankruptcy less likely.
And logically I have to agree with that. It also seems to me, that is not what caused the crisis.
I think the core of the problem is
A) Too much risk was taken on because there was huge incentive to maximize profit, and very little disincentive to minimize risk. People were gambling with other people's money.
B) Companies that were allowed to get too big to fail.
So I think we can keep mark to market, and naked short selling and even the repeal of Glass-Steagall as long as we have legislation in place to prevent systemic risk.
Something like monopoly laws, but instead of monopoly, companies would be charged with being too big to fail.
If the courts convict them of being systemic risk, they have to find a way to split into at least two parts, but they can do it while preserving as much share holder value
as possible.
And then no more bailouts!
I am not sure how Glass-Steagall eliminates systemic risk and the too big to fail scenario? It makes it less likely but does it eliminate it?
You do realize that the popular catchphrase "Too Big To Fail" is politician-speak for "We know these guys are crooks and we know they committed fraud on a massive scale, but won't indict them because it would bare our own corruption and failure to enforce existing laws because we really wanted our friends to make more money and donate to the campaign!"
I kind of agree with that, but it's also oversimplifying.
Putting banks into receivership doesn't just happen magically, there's laws for it. There are no equivalent laws for international behemoth insurers like AIG. The government can't just make up laws as it goes along.
As to a disorderly unwinding like Lehman, well that basically caused a run on the banks.
The government can't just make up laws as it goes along.
You are right, and I'm glad you are saying it :)
But didn't the Fed fail in it's regulatory role over the commercial banks to whom AIG was counterparty on swaps, when they allowed valuation of Tier Capital assets based on the 'quality' provided by swaps from AIG and friends? With any due diligence whatsoever the banks would have known that AIG didn't have the capital to pay those contracts. From that angle it looks like some or all of: The Fed was asleep, AIG misrepresented itself to CDS customers, or banks were complicit in the misrepresentation (or they didn't care because they could hedge the CDS with short CDS from a different counterparty -- now that is systemic risk). Go a step further -- the Fed accepted these CDS-wrapped assets as collateral for TSLF/TALF loans -- so the same statements about banks could be applied to the Fed, they either didn't do the due diligence on the collateral or they are complicit in breaking the law. Right?
Edit: for God's sake, I despise economics. I just want to get back to work and create stuff!
Absolutely, regulators failed all over the damn place.
But I'm not sure how to fix that. It seems they will be merged into one giant super regulator, I'm not sure that helps. Perhaps making the head of the super regulator an elected office?
And sorry about keeping you from work :) I'm in a cubicle farm... but won't be there for long.
"Too big to fail" is also an euphemism for "too big to obey the law."
> Because this didn't start on November 5th, 1999. This started on April 6th, 1998, a year and a half before Gramm-Leach-Bliley passed, and it started with one man telling the federal government that he just plain wasn't going to obey the law, and that man's name was Sanford I. "Sandy" Weill. Sandy Weill's purchase of Citibank, as CEO of the brokerage and insurance company Travelers Group, was euphemistically called a merger, but it was Weill who was calling the shots, and he was open from day one as to what he was doing: intentionally violating Glass-Steagall, the law that prohibited banks from owning brokerages and vice versa. He didn't agree with the law, he wanted it changed, he believed that banks should be able to gamble on more risky assets, and he intended to get even richer doing so. Under the terms of Glass-Steagall, on April 6th, 1998 a two-year countdown clock to the destruction of Citibank automatically began. If he was going to obey the law, he had until then to announce a plan to spin off all of the departments that Glass-Steagall said a bank couldn't own, and then another three years after that to complete the sales, or else surrender his banking license to the FDIC. Instead, he said, in effect, "come and pry it out of my cold, dead hands. Go ahead, kill off the single largest and most important bank in the world for being a scofflaw. I dare you," in terms almost that blunt.
> Congress blinked. On almost the last possible day they could do so, they revoked the FDIC's permission to yank his banking license. Why? Because Citibank was too big to fail. And that meant that it was too big to be forced to obey US law. And to the right-wing Democrats in the White House, and the Republicans in Congress, that was just okay with them. Only a few "far-left" "radicals" and "extremists" thought otherwise. Who were the American people supposed to believe, a tiny minority of "far-left" "radical" "extremist" "socialist" nobodies, or "historians," "economists," "financial experts," college professors from "top universities," "successful entrepreneurs," senior spokesmen for both parties, and the President's own Treasury Secretary?
> And I'm sure if you ask President Obama about any of this, he'll put on the usual basset-hound expression that he wears when you ask questions about prior misconduct, and give his usual stern speech about "looking forward, not backwards" (when refusing to look backwards is exactly what got us into this mess in the first place).
I agree on your point B, I think that companies can get to a point where they are like a cancer, they themselves thrive (for a while) but they can end up destabilizing the host organism. Not a perfect analogy, and I worry about giving the government the power to declare that a company is "too big" because historically such powers are abused. IF such size could be pre-defined on purely objective measures, perhaps there is a way it could work.
I think the rules can be fairly simple, if you have more than 5 billion a year (inflation adjusted starting now) in revenue and control more than 33% of the market you should be treated like a monopoly. That way small / midsized markets can be dominated by a single company which can be extremely efficient but no single company can become "to big to fail".
But other lawmakers criticized the provisions of the legislation aimed at discouraging community groups from pressing banks to make more loans to the disadvantaged. Representative Maxine Waters, Democrat of California, said during the House debate that the legislation was ''mean-spirited in the way it had tried to undermine the Community Reinvestment Act.'' And Representative Barney Frank, Democrat of Massachusetts, said it was ironic that while the legislation was deregulating financial services, it had begun a new system of onerous regulation on community advocates.
What really gets me, is that the very people that were pushing for banks to loan money to people who couldn't afford the loans (ie Barney Frank), are out there in the media as the biggest decriers of the financial mess we are in. They are so eager to lay the blame on others, including big, nasty Wall Street. Everyone is culpable here.
Holy crap - this is the most succinct explanation I've seen of the economic crisis:
"The opponents of the measure gloomily predicted that by unshackling banks and enabling them to move more freely into new kinds of financial activities, the new law could lead to an economic crisis down the road when the marketplace is no longer growing briskly."
Yes, that's definitely a big part of it - the fact that the same company can both provide a loan and then insure that same loan creates an ethical conflict of interest that calls into question their ability to objectively quantify risk, as well as creating an illusion of stability with these risky assets through false claims of insurance. The article gave an example of a company at the time (Citigroup) that would have had to split their insurance underwriting by law, which arguably would've created a more accountable and less entangled situation than having it all under one roof.
So what did the less ethical banks do with these troubled assets, since I'm sure somebody in the top ranks had to know what they were getting into? Bundle them up with a bunch of their other more reputable financial products and resell them to others. That's the part that's been getting a lot of the attention lately but it's only a symptom, not the root cause of the problem.
that the same company can both provide a loan and then insure that same loan
Give me a source, please. That isn't legal -- when Enron did it, after Glass-Steagal was ended, they got in a lot of trouble. In fact, Enron and the monolines are the only example I can think of where this applies. Which other companies were doing it?
But the problem is when they don't market the insurance to market (or when they mark different kinds of insurance to different market prices). Work it out with an example: let's say a bank owns a $100 loan. The borrower gets into trouble, and the loan must be written down to $90. So the bank reports a $10 loss. Whereas, if the bank insures the loan, and it gets written down to $90 -- their insurance liability gets written up to $10, leading to the same loss. The only thing that would make a difference would be fraud, which I don't believe has been legalized.
The article gave an example of a company at the time (Citigroup) that would have had to split their insurance underwriting by law, which arguably would've created a more accountable and less entangled situation than having it all under one roof.
Now you're just getting tautological: Glass-Steagal creates accountability and reduces entanglement because repealing Glass-Steagal reduces accountability and increases entangelemnt.
So what did the less ethical banks do with these troubled assets, since I'm sure somebody in the top ranks had to know what they were getting into?
So they, um, sold things? That is the super serious criminal accusation? That they bought stuff, and they sold it to people who overpaid? Pretty sure investment banks could already do that. And that's only possible if people are overpaying for assets.
Your argument appears to consist of 1) fallacies, 2) fabrications, and 3) statements that can only be true if you accept my argument from elsewhere in the thread -- that this bubble was made possible only by government regulations.
> Yes, that's definitely a big part of it - the fact that the same company can both provide a loan and then insure that same loan creates an ethical conflict of interest that calls into question their ability to objectively quantify risk
> So what did the less ethical banks do with these troubled assets, since I'm sure somebody in the top ranks had to know what they were getting into? Bundle them up with a bunch of their other more reputable financial products and resell them to others.
The combination of those two sentences doesn't make any sense.
The inability of an insitution to objectively quantify risk wrt a given entity doesn't matter if said institution doesn't own or insure said entity.
In other words, it doesn't matter how bad Citigroup is at estimating the risk of assets that it sells.
The problem is they sold the "good slices of the pie" and nobody would buy the bad slices. So they had a lot high risk assets on the books. Which was fine until the market decline wiped their value out.
"The claim was that Citi can't distinguish good from bad."
That's not the claim at all - it's that they had a sliding scale of how bad a loan they were willing to make because of incentive to have lax ethical standards, then they hid the "badness" of those loans by bundling them up with other financial vehicles that they resold to others.
Actually that is the claim - "fact that the same company can both provide a loan and then insure that same loan creates an ethical conflict of interest that calls into question their ability to objectively quantify risk"
Of course, the insurance that we're talking about wasn't for individual mortgages but for loan portfolios and tranches of loan portfolios. (The "insurance" wrt the effect of individual loans comes from the portfolio - instead of "loan fails or not", you get "fraction of loans that fail".)
> it's that they had a sliding scale of how bad a loan they were willing to make because of incentive to have lax ethical standards
That's completely incorrect. The "how bad a loan" stuff came from loan orignators as pushed by CRA, govt officials, and fannie and freddie.
Ethics had nothing to do with it. Or rather, the "ethic" of "folks should get a loan regardless of whether they can repay" overrode the financial reality of "loans made to people who are unlikely to be able to repay are likely fail".
Citigroup wasn't big in loan origination. They did their "magic" on portfolios that they bought from other magicians and from folks who originated loans.
> the fact that the same company can both provide a loan and then insure that same loan creates an ethical conflict of interest that calls into question their ability to objectively quantify risk
That doesn't make sense.
If I sell you a car, how does selling you insurance against repair costs bring my ability to objectively qualify the risk of it needing repair?
In pricing that insurance, there are three possibilities. If I price it too low, I'm saying that it is less risky than it actually is, so if you buy,insurance, you get a deal and I take the loss. If I price it accurately, it doesn't matter whether you buy it. If I price it too high, that price tells you that I think that the car is riskier than you might have thought. Buying the insurance is a bad idea, but if you got a bargain by buying "risk" that you're not actually incurring, you're ahead.
In short, pricing insurance incorrectly hurts Citicorp.
Note that "mark to market" was reinstituted in 1999 after having been suspended in 1934.
Mark-to-market says that the value of an asset for regulatory purposes (bank or insurance company assets for example) is 0 on any day when no one offers to buy said asset or something comparable.
Many/most of these loan portfolios are throwing off cash. If anyone actually believes they're truely worth $0, I'll be happy to take as many as I can get for $1 each.
No. You've got that wrong. There are 3 types of valuations for assets:
"Level 1" which means that there is an observable price (a market and price) for this asset - such as a stock market. This is called "mark to market."
"Level 2" which means that there is no observable price. It takes an observable price and uses it as an input to some formula to produce a value. This is commonly called "mark to model" and derivatives are the most widely known products in this area.
"Level 3" asset valuation is where the asset holder makes up a value. Many call this "mark to make believe." Most of the profits in the past couple years in the financial industry were "level 3 profits."
The FASB's view on valuing the balance sheet of companies is to use "level 1" (if it exists), before using the other valuation methods. If there are enough CDOs sold that there is now a price for that CDO, then the only rational thing is to use that price - not the one that was made up. Until FASB 157 came out, if a company wanted to claim that their level 3 assets were worth what they said they were worth, then they could. Now, if there is a "street price" for the assests, then you have to use "mark to market."
I think GLB is irrelevant at this point, if only because regulators were negligent in failing to enforce other existing laws which could have prevented and/or mitigated the implosion. Would the executive branch have behaved differently if Glass-Steagall were still in place?
I find it highly ironic that the same bill that was largely responsible for our banking crisis actually REDUCED ACORN loans, and yet talk radio blames those loans for the whole crisis.
not only is this a warning about history, but it is one about politics.
we voted for this via popular support across the world. we took popularism and democracy too far. the populous was wrong, so....
my question is, how do you design a system that both accommodates the population of your system, but also allows success with counter examples?
i am afraid that wikipedia will develop a sedentary culture, and will slow down in its rate of change, hence making it corruptible. so how do we fix that, how do we protect communities from them selves?
Being right is tough, especially when you're not vindicated until years later (and after years of "success" by the new policies).
More:
"''Scores of banks failed in the Great Depression as a result of unsound banking practices, and their failure only deepened the crisis,'' Mr. Wellstone said. ''Glass-Steagall was intended to protect our financial system by insulating commercial banking from other forms of risk. It was one of several stabilizers designed to keep a similar tragedy from recurring. Now Congress is about to repeal that economic stabilizer without putting any comparable safeguard in its place.''
Supporters of the legislation rejected those arguments. They responded that historians and economists have concluded that the Glass-Steagall Act was not the correct response to the banking crisis because it was the failure of the Federal Reserve in carrying out monetary policy, not speculation in the stock market, that caused the collapse of 11,000 banks. If anything, the supporters said, the new law will give financial companies the ability to diversify and therefore reduce their risks. The new law, they said, will also give regulators new tools to supervise shaky institutions.
''The concerns that we will have a meltdown like 1929 are dramatically overblown,'' said Senator Bob Kerrey, Democrat of Nebraska."