Could Reviving a Defunct Banking Rule Prevent a Future Crisis?

The Atlantic features John Berlau's argument against the revival of the Glass-Steagall rule. 

Election years are a time when politicians put on their favorite pair of rose-colored glasses and make future plans with an idealized view of the past. This year, that shiny object for many in both parties is Glass-Steagall. Glass-Steagall is touted as being of progressive origins, reining in big Wall Street banks, and bringing stability to the financial sector. But none of these claims square with reality.

First, the law’s sponsors, Senators Carter Glass of Virginia and Henry Steagall of Alabama, were not progressives but “Dixiecrats” who championed the “Jim Crow” segregated American South. Glass helped design Virginia’s poll tax and literacy test for the express purpose, in his own words, of ensuring “the complete supremacy of the white race in the affairs of government.” Glass’s horrific views on race don’t translate into him being automatically wrong on everything else, but they do at least warrant much more skepticism of his other ideas on public policy.

Second, since Glass-Steagall forbade “Main Street” commercial banks from venturing into investment banking, it actually protected Wall Street investment banks such as Bear Stearns and Goldman Sachs from competition, enabling them to get bigger. Through the 1980s, the Securities Industry Association, a trade group for investment banks, lobbied and litigated against any loosening of the law. And in the end, it was pure investment banks such as Bear and Lehman Brothers—neither of which had merged with commercial banks—that were the first dominoes to fall in the financial crisis.

To really curb the problem of “systemic risk”—or banks that are “too big to fail”—we must bring to the financial sector what virtually every other field of American business possesses: competition. Companies such as Borders and Blockbuster once dominated their industries but their implosions—while difficult for employees and stockholders—didn’t trigger a crisis. This is largely because competitors were standing ready to absorb demand from their customers.

But in the financial industry, policy makers have mistakenly thought an answer to ensuring stability is to limit competition. Since 2010, federal regulators have approved only two new banks to operate in the U.S. Before then, even in the depths of the savings-and-loan crisis, more than 100 new banks per year would get the green light from regulators to open.

Also, unlike virtually every other industrialized nation, the U.S. effectively bans non-financial corporations from owning bank affiliates. During the George W. Bush administration, some of the best-run American corporations—including Walmart, Home Depot, and Warren Buffett’s Berkshire Hathaway—tried and failed to get regulatory approval to create banking units. By contrast, in the United Kingdom, one out of eight pounds [units of currency] are taken from the cash machines of Tesco Bank, a division of the retail giant Tesco. And Canada and Mexico have allowed Walmart to operate the very banking units there that were denied to them by regulators here.

Financial stability can also be bolstered by creating special bankruptcy laws for the financial sector and limiting taxpayer-backed deposit insurance for the wealthiest savers, but allowing more competition must be at the forefront of any true financial reform.

Read the full article at The Atlantic.