Glass-Steagall: Still A Bad Idea

One my favorite writers (and fellow Marylander), H.L. Mencken, once observed: “Nothing is as enduring as a bad idea.” He would have loved the odd right and left-wing coalition seeking to bring back the Glass-Steagall Act which, simply put, precluded institutions that hold deposits from engaging in investment banking. It was repealed during the Clinton Administration.

No longer only the goal of the fading Larouche movement, support for the return of this 1933 relic has spread to the point it’s in both the GOP and Democrat platforms. It is supported by John McCain and Elizabeth Warren. Also Paul Volcker and Bernie Sanders. What a quartet.

It’s also on the agenda at the upcoming National Conference of State Legislators meeting in Chicago.

I understand the post-bank bailout anger and frustration felt by Americans who saw their home values and IRAs melt away while hedge fund managers shopped for new Bentleys and villas in the Hamptons.

The “Main Street versus Wall Street” political trope dates back to the Progressive Party. Emotion and class warfare is running high this election cycle so the political appeal is understandable.

Just one problem―it’s a bad idea. Eliminating the Glass-Steagall Act had nothing to do with the crash. Shadow banking, hedge funds, the commercial paper market, MBS, exotic derivatives etc. had nothing to do with Glass-Steagall. Lehman Brothers was purely an investment bank and AIG was an insurer. Neither would have been subject to Glass-Steagall. Nor, of course, would the buccaneers at Fannie and Freddie.

Proponents of Glass-Steagall miss the real challenge of how to deal with “too big to fail" institutions. The answer isn’t to curb their ability to diversify. Monoline companies can also be too big to fail, both in and out of banking. In Germany, the sheer size of VW means the government cannot seek the same redress available to US owners of Dieselgate cars. Teutonic drivers won’t be as well compensated because the cost would likely sink the company. VW is effectively too big to fail.

Forcing depository institutions and investment banks into Depression Era boxes won’t address systematic risk created by growing concentration in financial services. Instead, regional banks that have brokerage businesses would have to break up if they offer both investment and commercial banking.

While Glass-Steagall may make proponents feel better, policymaking by tantrum is a bad idea.