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Breaking the Glass-Steagall Myth

By / 12.18.2009

Bank of America Tower, Seattle, WAWord going around Washington this week is that Sens. John McCain (R-AZ) and Maria Cantwell (D-WA) are pushing to reinstate Glass-Steagall:

McCain and Cantwell, a Washington Democrat, join other lawmakers in Congress proposing to reinstate the 1933 law, repealed a decade ago by the Gramm-Leach-Bliley Act that led to a rise in conglomerates including Citigroup Inc., JPMorgan Chase & Co. and Bank of America Corp. active in retail banking, insurance and proprietary trading. Legislation to reinstate the ban was introduced today in the House.

While this move is a well-meaning attempt to rein in the financial sector, it doesn’t address the issues that caused last fall’s crisis.

Glass-Steagall was aimed at separating “boring” retail banking (the Bailey Building and Loan Association, for example) from “risky” investment bankers (Gordon Gekko). It was eventually repealed, as U.S. banks felt it put them at a disadvantage in the global marketplace against European “universal” banks, such as Deutsche Bank, Credit Suisse, and HSBC.

At the time there was concern that repealing Glass-Steagall would create banks that were systematically dangerous. In hindsight, that concern would seem to be born out — but it isn’t. After all, the three major bank collapses that precipitated the crisis were Bear Stearns, Merrill Lynch, and Lehman Brothers. All three were obviously Too Big Too Fail, but all three would have been unaffected by a reinstatement of Glass-Steagall — none of them is a retail bank (this is why you never saw Merrill or Lehman ATMs).

Rather than focusing on micromanaging bank structure, and stifling entrepreneurship in the financial sector, the Senators would be better served by evaluating different options to limit the size of Too Big Too Fail banks. A smarter idea would be to extend the retail bank deposits cap idea to total bank assets. Currently, no bank can have more than 10 percent of total national retail deposits (Bank of America got a waiver for the 2007 purchase of Chicagoland’s LaSalle bank and now has 12.2 percent of national deposits). Peter Boone and Simon Johnson suggest applying this simple principle to total bank liabilities. They recommend a limit of 2 percent of GDP, which is in line with the $300 billion that Felix Salmon has been recommending since March. Importantly, it’s also in line with the de facto $100 billion threshold that bank regulators are using now.

This way the government isn’t running banks and bankers can pursue the capitalist impulse that drives our economy. But with a cap on liabilities, the decisions of bankers cannot threaten our economy like they have in the past.