Beware of Glass-Steagall


When freshman congressman and former lieutenant colonel Allen West was chosen to give the coveted keynote speech to close the Conservative Political Action Conference, he told National Journal that he would “be challenging conservatives to reaffirm their commitments to the fundamental principles of what we believe.”

Unfortunately, while the vast majority of West’s speech was smart, heartfelt, and moving, it also affirmed a dangerous liberal myth about the causes of the financial crisis.

“Do you believe that America can survive as a bureaucratic nanny state?” West asked the audience, eliciting a round of no’s from the regulation skeptics attending. But West then attacked repeal of one of the most bureaucratic rules of the nanny state of the 1930s: the Glass-Steagall Act, which separated commercial and investment banking, limited consumer choice, and harmed U.S. competitiveness.

In talking about the financial crisis (at 12:25 in the 32-minute speech here,) West fingered many of the right culprits. Listing the reasons for the collapse, West said, “Go back and study the Community Reinvestment Act.#…#when we create an agency like Fannie Mae and Freddie Mac, when we lower down the standards for lending.” He concluded that if government had gotten “out of the way of the private sector, [the recession] would not have happened in 2008.”

But in the middle of this passage, West inexplicably condemned a bipartisan action to get government out of the way: the 1999 repeal of Glass-Steagall in the Gramm-Leach-Bliley Act that was signed by President Clinton and passed overwhelmingly by the GOP-controlled Congress. Adding to his reasons for why the financial markets collapsed, West said, “When we get rid of Glass-Steagall, and we now start to securitize our mortgages, and we sell off bad mortgages throughout our own financial industry and overseas.”  

West isn’t the first right-of-center figure to echo the Left’s populist arguments against Glass-Steagall repeal. Even after John McCain had tacked right on most issues in the months leading up to his primary against former Arizona representative J.D. Hayworth in 2010, he still co-sponsored a bill restoring Glass-Steagall with Sen. Maria Cantwell (D., Wash.) At, contributor Morgan Warstler attempted to wrap Glass-Steagall in Tea Party populism. “With Glass-Steagall back in place,” he wrote, “we have far less to worry about. Goldman Sachs will no longer be our Treasury Department.”

For West, Warstler, and McCain, supporting Glass-Steagall seems to be a way of showing their anti-Wall Street bona fides. But if Glass-Steagall is resurrected, regional banks that can now offer their customers insurance and investment services will likely be hurt much more than financial giants such as Goldman Sachs. Moreover, ending Glass-Steagall under Clinton had about as much to do with the financial crisis as airline deregulation under Jimmy Carter!

In going into what Glass-Steagall and its repeal actually did, it’s useful to explain what the law didn’t do. Its prohibition on banks having securities affiliates had nothing to do with mortgage securitization. Banks had been selling off their mortgages for decades before the law’s repeal. In fact, Fannie Mae was created in 1938 with the express purpose of buying mortgages from banks, so there would be more liquidity in the housing market.

Rather, what Glass-Steagall restricted was the services, such as investment and insurance, that bank holding companies could provide to their customers. Gramm-Leach-Bliley permitted banking firms to once again offer these services for their customers, if they are walled them off from federally insured deposits.

The result has been more choice for consumers and the convenience of “one-stop shopping” for financial services. As noted by an article in “For much of the 20th Century,#…#clients had to use an investment firm for investing in assets like stocks and bonds but use a separate commercial bank for checking services and an insurance company for insurance services. Now, investment firms can provide all of these services to their clients.”

And to what extent did banks’ ability to provide these previously barred services contribute to the financial crisis? Try zero. As Peter Wallison, co-director of financial-policy studies at the American Enterprise Institute and former general counsel for the Reagan Treasury Department, wrote in his recent dissent in the report of the Financial Crisis Inquiry Commission, “There is no evidence#…#that any bank got into trouble because of a securities affiliate.”

As Wallison noted in the Wall Street Journal, “None of the investment banks that have gotten into trouble — Bear, Lehman, Merrill, Goldman or Morgan Stanley — were affiliated with commercial banks.” He also pointed out that “the banks that have succumbed to financial problems — Wachovia, Washington Mutual and IndyMac, among others — got into trouble by investing in bad mortgages or mortgage-backed securities, not because of the securities activities of an affiliated securities firm.”

In fact, the lifting of barriers to financial-service mergers from Glass-Steagall’s repeal likely lessened the financial crisis’s impact, because banks were able to purchase failing brokerage houses. As Clinton, who still defends the repeal, said in a Business Week interview: “Indeed, one of the things that has helped stabilize the current situation as much as it has is the purchase of Merrill Lynch by Bank of America, which was much smoother than it would have been if I hadn’t signed that bill.”

And any restoration of Glass-Steagall could have a devastating impact on Main Street banks still struggling from the real-estate bust. The respected InvestmentNews reports that “regional banks, still reeling from their real estate exposure, are finding relief — and a healthy measure of profitability — in their wealth management businesses.” Wealth management runs the gamut of financial services from deposits to investments and insurance, activities that would be prohibited if Glass-Steagall were to return.

In fact, the “Volcker Rule” from the Dodd-Frank financial “reform,” which restricts bank trading and has been called “Glass-Steagall Lite,” could hit banks’ ability to provide these services. The rule bans banks from “proprietary trading” or trading for banks’ own portfolios, while purporting to still allow investing on behalf of customers.

But a recent study by the respected Oliver Wyman consulting firm for the Securities Industry and Financial Markets Association shows all investing may be harmed. “Supporting customer trade flows often requires a larger number of additional trades to balance a dealer’s overall risk position and to maintain markets,” the study notes. If regulators interpret the rule to outlaw these essential trades on behalf of customers, the result would be “higher trading costs and consequently lower returns over time for investors,” the study says.

Given the passion West expressed against big government in most of his CPAC speech and elsewhere, he could be an articulate spokesman for defending America’s investors and entrepreneurs from this type of overregulation. But first, he and others must shatter the Glass-Steagall mythology of the Left that has crept into the narrative of the populist Right.

A good place to start for those on the Right tempted to jump on the pro-Glass-Steagall bandwagon would be Wallison’s incisive FCIC dissent. Tracing 27 million risky or subprime loans to Fannie and Freddie and/or the CRA mandates, Wallison concludes that while other factors (but not Glass-Steagall repeal) were at play, “the sine qua non of the financial crisis was U.S. government housing policy.” And the sine qua non of real financial reform — which West will hopefully become of a leader of — should be countering government subsidies and overregulation.