Brian T. Watson
The Salem News
---- — Congressman John Tierney, with Republican Rep. Walter Jones, has introduced legislation to reinstate certain provisions of the Glass-Steagall Act. I strongly support their proposal. Understanding it requires some background.
Depending upon exactly when we mark the start of the great Wall Street meltdown of 2007 and 2008, we have been assessing its causes (and effects) for about six years. Of course, the reality is — as with most complex historical events — there is no one, tidy event or single date that precipitated the crisis.
Actually, the forces and developments behind the meltdown — those decisions and dynamics that created an unsustainable financial system that finally collapsed — most accurately could be said to have begun 35 years ago during the administration of President Jimmy Carter.
It was during his tenure that he, Congress, the private sector and the courts first started to embrace greater efforts to deregulate industry and private enterprise. Attempting to give businesses and the market more freedom from government control, they reduced or eliminated various regulations on the trucking, railroad, airline and financial sectors.
This was an uneven and often incremental process, and it continued under President Ronald Reagan and every subsequent president until the meltdown started under President George W. Bush. The deregulatory steps in the financial sector were especially arcane and less obvious to the ordinary citizen. Because so many agencies and entities — among them the Securities and Exchange Commission, the Office of the Comptroller of the Currency, the Federal Reserve System and the federal courts — are involved in monitoring and interpreting the rules governing banking, lending, investing, trading and hedging, only true policy wonks and insiders follow the regulatory processes closely.
But especially after 1990 or so, the financial sector increasingly enjoyed greater and greater latitude. One of the significant changes that evolved was the slow erosion of the provisions of the Glass-Steagall Act, which had been in place since 1933.
The GSA placed a sort of “firewall” between the activities of traditional, community commercial banks and the activities of the usually larger and more audacious investment banks and firms. Under the GSA, commercial banks that accepted FDIC-insured deposits and lent money to homeowners and small businesses — using long-standing best practices that had traditionally been proven to be prudent — were prohibited from engaging in the riskier businesses of speculative investment, opaque swaps dealing, hedge fund activities, market-making, and “synthetic” financial products — in short, many of the activities that played a large role in making the Wall Street crisis so serious and far-reaching. The theory (borne out in practice) was that banks should not be allowed to gamble with depositors’ savings accounts. By contrast, the investment and securities firms were governed by a different set of rules.
But throughout the 1980s and 1990s, both commercial and investment banks lobbied continuously to slowly dismantle the firewall. As the two bank types increasingly associated, the regulatory agencies and the courts repeatedly decided in favor of loosening the GSA prohibitions. Finally, in 1999, the Glass-Steagall Act was repealed, although that was just making official what was already substantially the reality.
Tierney’s legislation would once again create a larger division between depository banks and investment and securities firms. The law’s purpose would be multifold. It would reduce the size of the largest banks, as they would be required to spin off their strictly FDIC-depository functions. It would reduce risk to the overall financial system — and to ordinary savers — by confining to investment firms the riskiest speculation and most complicated financial schemes. Lastly, it would reduce conflicts of interest where bank profits are earned at the expense of their customers.
Although many factors caused the banking meltdown, a major one was the enormous extent of reckless, unregulated bank behavior. With so many complex, opaque financial instruments that often did not show up on the banks’ conventional balance sheets, or were otherwise nearly impossible to track and understand, there were insufficient controls and restraints on the speculative activities of bankers and traders.
The proliferation of credit default swaps, collateralized debt obligations, “synthetic” versions of those, and hybrid collections of mortgages, student loans, insurance policies and credit card debt were all just “constructs” with which to speculate unrestrainedly.
Banks were just out of control. Right before the meltdown, the total value of financial derivatives in circulation globally was roughly $685 trillion. Think of that sum as a gambler’s wager, not money being put to good use underwriting real businesses with actual products and employees. And that sum, shockingly, was roughly 10 times the value of all of the real goods and services being produced at that moment across the entire world.
Tierney’s legislation would join the Dodd-Frank law (still being implemented) in adding to our still-evolving efforts to address causes of the meltdown. No one law is going to be the magic bullet. But in general, we seem to agree that there is still too much risk in the system, and too much potential for crises. Reinstating the constructive rules of the Glass-Steagall Act would help to add stability to our financial system.
Brian T. Watson is a Salem News columnist. Contact him at firstname.lastname@example.org.