Saturday, July 31, 2010

A simple fix for our financial system

Crude timeline:
1929-Greedy wall street bankers crash economy and cause Great Depression
1933-To prevent another crash, the Glass-Steagall Act is passed
1999-Republican Phil Gramm introduces a bill to repeal Glass-Steagall which passes in November with broad bipartisan support
2007-Greedy wall street bankers crash economy and cause Great Recession

The put it simply, Glass-Steagall said that commercial banks could not participate in the same risky activities as investment banks. So, consumers could choose what sort of financial exposure they were subject too. Want to put your money in a safe place? Put it in a commercial bank. Want to make money by risking your money in the stock market? Put it in an investment bank.

The stock market is kind of like a casino. Certain folks control it and know how it works and the rest of us just try to get lucky. Consequently, there are a lot of good reasons why we might want to keep our money out of the stock market. For more on this, here's Jon Stewart for four minutes:

In 1999, since Glass-Steagall had served us well for over half a century, our brilliant elected officials decided to fix something that wasn't broken... and then dropped it and shattered it on the floor.

In late 2009, Senators McCain (R-AZ) and Cantwell (D-WA) attempted to clean up the mess and proposed reinstating Glass-Steagall. Instead, congress (after the conference committee) passed a financial reform bill that contained a watered down version of the Volcker Rule (essentially a watered down version of some of Glass-Steagall). So, a bill with some really good loopholes.

Side note: The fact that McCain took part in the effort to reinstate Glass-Steagall is strange. During the 2008 presidential campaign, McCain hired Phil Gramm (the original culprit here) to be his chief economic advisor. Clearly McCain has had a change of heart, or during the campaign, the guy who was writing his economic policy disagreed with him fundamentally.

While I acknowledge that there are more problems with our financial system than just a partition between commercial and investment banks, reinstating Glass-Steagall would go a long way toward fixing the problem. Certainly, the meltdown we experienced would not have been nearly as widespread as it was and would have probably been relegated to traditional investment entities rather than permeating the entire system.

The bigger issue here is that by removing the barrier between commercial banks and investment banks, we also remove the delineation of what banks are insured by taxpayers. Under Glass-Steagall, taxpayers were only on the hook for commercial banks; investment banks could take all the risks they want, but they would be responsible for the consequences of those risks. Without the separation of Glass-Steagall, taxpayer responsibility is much less clear. Consequences include paying $700 billion in TARP funds (though we're getting most of this back) to banks that have gotten into trouble.

Opponents of financial regulation point out that regulation raises the cost of doing business. However, we must realize that the short-term cost of protecting ourselves is far outweighed by the long-term cost of saving our entire financial system every time wall street bankers lose themselves to greed.


  1. "I hope we shall crush in its birth the aristocracy of our monied corporations which dare already to challenge our government to a trial by strength, and bid defiance to the laws of our country."
    -Thomas Jefferson

    How spot on was Jefferson with that?

  2. Jefferson was spot on about quite a few things. The quote on your blog is one of his better ones.