I want to continue on the theme of last night’s post, which essentially is that those who do not remember their history are doomed not to repeat it but to never escape it.
I took some flak on Facebook for a comment I made about Bill Clinton contributing to the financial meltdown because of his role in taking down the firewall between investment firms and banks that had been created during the New Deal.
The New York Times describes the Glass-Steagall Act (aka, the Banking Act of 1933) “as an emergency response to the failure of nearly 5,000 banks during the Great Depression.”;
It gave tighter regulation of national banks to the Federal Reserve System; prohibited bank sales of securities; and created the Federal Deposit Insurance Corporation (FDIC), which insures bank deposits with a pool of money appropriated from banks.
The law, part of the New Deal, was a response to the public loss of confidence in the banking system after the stock market crash and bank runs that led to hundreds of banks shutting their doors.
Beginning in the 1900s, commercial banks established security affiliates that floated bond issues and underwrote corporate stock issues. (In underwriting, a bank guarantees to furnish a definite sum of money by a definite date to a business or government entity in return for an issue of bonds or stock.) The expansion of commercial banks into securities underwriting was substantial until the 1929 stock market crash and the subsequent Depression. In 1930, the Bank of the United States failed, reportedly because of activities of its security affiliates that created artificial conditions in the market. In 1933, all of the banks throughout the country were closed for a four-day period, and 4,000 banks closed permanently.
As a result of the bank closings and the already devastated economy, public confidence in the U.S. financial structure was low. In order to restore the banking public’s confidence that banks would follow reasonable banking practices, Congress created the Glass-Steagall Act. The act forced a separation of commercial and investment banks by preventing commercial banks from underwriting securities, with the exception of U.S. Treasury and federal agency securities, and municipal and state general-obligation securities. Likewise, investment banks may not engage in the business of receiving deposits.
The legislation was never popular with the banking and investment sectors, but the New Deal was considered sacrosanct for years preventing the rule from coming under attack.
Beginning in the 1970s — with Nixon and then Carter — there was a shift in attitudes on regulations and the transportation sector was deregulated. The energy sector followed, along with the easing of some regulations in banking (a factor in the Savings and Loan crisis of the ’80s). Every president from Nixon through George W. Bush engaged in the deregulatory fever, which gave more power to industry by stripping some legal oversight from government but also by creating an atmosphere in which oversight was considered anti-business.
This brings me to Glass-Steagall and Bill Clinton. The Glass-Steagall rules already had been weakened by the time Clinton’s treasury secretary, Robert Rubin, and Congressman Jim Leach (R-Ia.) starting working to remove these prohibitions from the law. The Clinton administration already had approved several mergers of investment and commercial banking entities, so the passage of the Gramm-Leach-Bliley Act was seen as a logical next step.
It also was part of a larger philosophical push in the Clinton administration to allow for more “creativity” in the financial sector, an effort that resulted in more mergers and a host of new — and questionable — banking products.
Here is how Time Magazine described the Clinton era in a piece on “The 25 people to blame for the financial crisis“:
President Clinton’s tenure was characterized by economic prosperity and financial deregulation, which in many ways set the stage for the excesses of recent years. Among his biggest strokes of free-wheeling capitalism was the Gramm-Leach-Bliley Act, which repealed the Glass-Steagall Act, a cornerstone of Depression-era regulation. He also signed the Commodity Futures Modernization Act, which exempted credit-default swaps from regulation. In 1995 Clinton loosened housing rules by rewriting the Community Reinvestment Act, which put added pressure on banks to lend in low-income neighborhoods. It is the subject of heated political and scholarly debate whether any of these moves are to blame for our troubles, but they certainly played a role in creating a permissive lending environment.
Barry Ritholtz, writing at The Big Picture, a financial blog, makes a similar point. It was part of a larger effort that implicates at least seven presidents and hundreds of politicians of both parties who were pushed by an industry that has come to have an outsized role in funding our political campaigns and, therefore, in making rules.
The repeal of Glass-Steagall may not have caused the crisis — but its repeal was a factor that made it much worse. And it was a continuum of the radical deregulation movement. This philosophy incorrectly held that banks could regulate themselves, that government had no place in overseeing finance and that the free market works best when left alone. This belief system manifested itself in damaging ways, including eliminating regulation and oversight on derivatives, allowing exemptions for excess leverage rules for a handful of players and creating dangerous legislation.
As the events of 2007 to 2009 have revealed, this erroneous belief system was a major factor leading to the credit boom and bust, as well as the financial collapse.
I have been unable to find any evidence that the Gramm-Leach-Bliley Act — the legislation that repealed Glass-Steagall — was a primary cause of the financial crisis. Imagine a “but for” scenario where Glass-Steagall had not been overturned but the rest of the deregulatory actions had still taken place. Would the crisis have occurred? Without a doubt, yes.
The Fed still would have taken rates down to unprecedented low levels. This would have led to a global spiral in asset prices. The nonbank, lend-to-sell-to-securitizer mortgage originators were still going to make subprime-mortgage loans to unqualified borrowers. Bear Stearns and Lehman Brothers would still have overwhelmingly increased exposure to subprime mortgages. AIG would still have written trillions of dollars in credit-default swaps and other derivatives with zero reserves set against them. The largest security firms and deposit banks would still have charged headlong into the subprime securitization business. And Fannie Mae and Freddie Mac would still have belatedly chased these banks into the same subprime market, just at the peak of the housing boom.
Lastly, housing prices would still have run up to absurd levels and then collapsed.
He goes on to make clear that “Glass-Steagall’s repeal allowed the credit bubble to inflate much larger” and “banks to be more complex and difficult to manage.”
When it all came down, the crisis was broader, deeper and more dangerous than it would have been otherwise.
The repeal of elements of Glass-Steagall helped facilitate the growing financialization of the economy and a crony capitalism that gives the leverage and investment firms and big banks more power over the economy than people who actually build things.
Clinton played a major role in all of this, as did every president starting with at least Jimmy Carter and running through George W. Bush. The point here is not to trash Clinton, but to insert a bit of historical perspective into the mix at a time when he is being lauded in the press and being loved by Democrats who insist on viewing the 1990s through rose-tinted glasses. Clinton has become the Democrats’ rock star, and the assumption is that criticism of his tenure in the White House either makes you a Republican or a crank.
We cannot begin to rebuild our economy unless we understand the failures of the recent past and honestly assess those in leadership positions.
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