Glass-Steagall Anyone?

“Our whole Depression was brought on by gambling, not in the
stock market alone but in expanding and borrowing and
going in debt, all just to make some money quick.”

—Will Rogers, May 5, 1935

Hot and heavy is the current debate (and rhetoric) over the need for increased regulation of the financial industry. Some believe it’s absolutely required, while those in the opposing camp feel it’s simply political posturing and demagoguery. Will limiting bonuses do the trick? Or do such measures really miss the root of the problem?

Now re-appearing in the debate is a review of the repeal in 1999 of a crucial segment of legislation created in a bygone era to protect against certain consequence-laden shenanigans of finance.

Included in the Glass-Steagall Act of 1933 were provisions prohibiting a bank holding company from owning other financial companies – thus separating commercial and investment banking to protect depositors from the dangers of risky investments and speculation. According to the New York Times, Glass-Steagall was:

“…enacted as an emergency response to the failure of nearly 5,000 banks during the Great Depression… Beginning in the 1900s, commercial banks established security affiliates that floated bond issues and underwrote corporate stock issues… 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…

In order to restore the banking public’s confidence that banks would follow reasonable banking practices, Congress created the Glass-Steagall Act… preventing commercial banks from underwriting securities… Likewise, investment banks may not engage in the business of receiving deposits.”[1]

In 1999, the interestingly named “Financial Services Modernization Act” (Gramm-Leach-Bilely) repealed Glass-Steagall’s prohibitions – permitting securities firms, banks, and insurance companies to affiliate.[2] The Senate passed the Act 90-8[3]. Only one Republican voted against it (Alabama’s Richard Shelby) – while seven Democrats opposed the measure.[4] Democrat Senator Byron Dorgan stated, “I want to sound a warning call today about this legislation… I think this legislation is just fundamentally terrible.”[5] Boston College finance professor Edward Kane warned “Nobody will be able to discipline a Citigroup.”[6] Ralph Nader bluntly opined at the time, “We will look back at this and wonder how the country was so asleep… It’s just a nightmare.”[7] They were not alone. In our opinion, it looks like time has proved them right.

On the other hand, then-Treasury Secretary and current Director of the White House’s National Economic Council for President Obama, Lawrence Summers, exulted, “Today Congress voted to update the rules that have governed financial services since the Great Depression and replace them with a system for the 21st century.”

Quite an “update” indeed.

Thus, one wonders whether President Obama’s recent proposals to impose restrictions on financial firms will actually have teeth. Using history as a guide – we think some old-fashioned “Glass-Steagall” might do some good.

As we enter this critical time – now, more than ever – we believe investors need to focus on their investment strategies. Those readers who are clients are fully aware of the strategies we’re implementing in light of unfolding economic circumstances. Others may feel free to contact us to learn more.

Stephan R. Ernharth, JD, AIFA
Vice President
Ernharth Group
www.ernharth.com

Go to www.ernharth.com/economic-commentaries to read past articles from our Economic Commentary series.

1.New York Times; “Glass-Steagall Act (1933)”; January 27, 2010
2.Ibid.
3.CounterPunch; “Shattering the Glass-Steagall Act”; September 19, 2008
4.Ibid.
5.The Huffington Post; “Glass-Steagall Act: The Senators and Economists Who Got It Right”; June 11, 2009
6.Ibid.
7.Ibid.