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Resurrecting Glass-Steagall
Resurrecting Glass-SteagallSIMON JOHNSON
Project Syndicate
This issue is sometimes referred to as “reinstating Glass-Steagall,” a reference to the Depression-era legislation – the Banking Act of 1933 – that separated commercial and investment banking. This is a slight misnomer: the most credible bipartisan proposal on the table takes a much-modernized approach to distinguishing and making more transparent different kinds of finance activities. Sanders and O’Malley are in favor of this general idea; Clinton is not (yet).
There are three main arguments against a modern version of Glass-Steagall. None is convincing.
First, some prominent former officials argue that not all of the financial firms that got into trouble in 2008 were integrated commercial-investment banking operations. For example, Lehman Brothers was a standalone investment bank, and AIG was an insurance company.
At worst, the argument is just plain wrong. Some of the greatest threats in 2008 were posed by banks – such as Citigroup – built on the premise that integrating commercial and investment banking would bring stability and better service.
Second, leading representatives of big banks argue that much has changed since 2008 – and that big banks have become significantly safer. Unfortunately, this is a great exaggeration.
Now, under the most generous possible calculation, the surviving megabanks have on average about 5% equity relative to total assets – that is, they are 95% financed with debt. Is this the major and profound change that will prove sufficient as we head through the credit cycle? No, it is not.
Finally, some observers – although relatively few at this point – argue that the biggest banks have greatly improved their control and compliance systems, and that the mismanagement of risk on a systemically significant scale is no longer possible.
This view is simply implausible.
The best argument for a modern Glass-Steagall act is the simplest. We should want a lot more loss-absorbing shareholder equity. And, to reinforce this, we should want to make the largest banks simpler and more transparent, with “strong structural firewalls” as Dennis Kelleher, of Better Markets, puts it. Of course, in that context, we should ensure that various activities by “shadow banks” (structures that operate with bank-like features, as Lehman Brothers did) are properly regulated.
There are three main arguments against a modern version of Glass-Steagall. None is convincing.
First, some prominent former officials argue that not all of the financial firms that got into trouble in 2008 were integrated commercial-investment banking operations. For example, Lehman Brothers was a standalone investment bank, and AIG was an insurance company.
At worst, the argument is just plain wrong. Some of the greatest threats in 2008 were posed by banks – such as Citigroup – built on the premise that integrating commercial and investment banking would bring stability and better service.
Second, leading representatives of big banks argue that much has changed since 2008 – and that big banks have become significantly safer. Unfortunately, this is a great exaggeration.
Now, under the most generous possible calculation, the surviving megabanks have on average about 5% equity relative to total assets – that is, they are 95% financed with debt. Is this the major and profound change that will prove sufficient as we head through the credit cycle? No, it is not.
Finally, some observers – although relatively few at this point – argue that the biggest banks have greatly improved their control and compliance systems, and that the mismanagement of risk on a systemically significant scale is no longer possible.
This view is simply implausible.
The best argument for a modern Glass-Steagall act is the simplest. We should want a lot more loss-absorbing shareholder equity. And, to reinforce this, we should want to make the largest banks simpler and more transparent, with “strong structural firewalls” as Dennis Kelleher, of Better Markets, puts it. Of course, in that context, we should ensure that various activities by “shadow banks” (structures that operate with bank-like features, as Lehman Brothers did) are properly regulated.
Related:
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MATT TAIBBI: Hillary Clinton's Take on Banks Won't Hold Up
Robert Scheer: Go Ahead, Back Hillary Clinton and Forget All About Her Record
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