Report From the White House: Would Glass-Steagall Have Saved Us?

We're not shy about advocating for shareholder rights and making sure our members are heard on important matters that affect our portfolios. That's why the White House asked for feedback from the Motley Fool community and agreed to answer your questions. Here is the third installment of our interview with Austan Goolsbee, chief economist for the President's Economic Recovery Advisory Board.

It's no surprise that investors in Fooldom are outraged about the risky practices and untenable leverage taken on by "too big to fail" financial institutions. That these companies were, in fact, doing business within the letter of the law is fuel for the White House's ambitious plan to overhaul financial regulation.

Many of you who made posts to our article calling for questions about the White House's financial regulation reform plan harkened back to the good old days, when Glass-Steagall was the law of the banking land.

  • Whatsafool wrote: "I have two words to deliver to the Administration: Glass Steagall. This law, dismantled by [former Sen. Phil] Gramm and his ilk, protected Americans from economic collapse very nicely, thank you, for 50 or so years."
  • Markgiese proposed warning labels such as the ones you see on cigarette boxes, to make sure investors know exactly how financial products and services affect the consumer's financial health: "Examples: Brokers don't make money because they help you increase your income, they make money on each completed transaction. Financial advisors don't make money when you successfully retire with a comfortable income. The growth of your nest egg provides a very small incremental improvement in the advisor's overall income. The initial sale is all they are paid to care about. ... Ratings agencies that are paid by the organizations they are rating cannot generate unbiased appraisals."
  • Lastly, 1ChefJeff painted a picture of how he thinks the rules of separation should work: "Reinstate the separation of banking from securities underwriting a la Glass Steagall but without the [loopholes] that existed in Glass Steagall. Banks need to provide credit to individuals and business. ... Insurance companies need to sell insurance. ... Brokers need to advise clients on stocks & bonds. ... Car [manufacturers] need to build cars, not loans. ... Retail chains need to sell product, not be banks ... and all of them need to be small enough to go out of business when they fail to provide what their consumer wants without a major shake-up to the financial marketplace."

Great comments, Fools. And so, on your behalf, David Gardner and I asked Austan Goolsbee, chief economist for the President's Economic Recovery Advisory Board, if new laws -- a la Glass-Steagall -- are in the cards.

Scroll down just a few inches to watch the video. Or read on for a briefing on the history of banking regulation and how the rules of the road have been changed over time.

Your Glass-Steagall refresher
Glass-Steagall was enacted in 1933, after that other big crash, to protect depositors and taxpayers from exposure to risky banking business practices. The gist of the law was that a company could be either a bank or a brokerage, but it could not be both.

For a while, Glass-Steagall -- along with the 1956 Bank Holding Company Act -- prevented financial institutions from mixing a combustible cocktail of banking and non-banking business, such as dealing in commercial paper and mortgage-backed securities. Then in the 1960s, banking-industry lobbyists began chirping in politicians' ears and got them to chip away at some of the restrictions. By the 1990s, Glass-Steagall was viewed as a relic of overly cautious regulation, and it was eventually repealed.

Flash forward to last year.

On these pages, we've previously debated whether we'd be in this financial mess even if Glass-Steagall were still in place. Read "Who's More to Blame: Wall Street or the Repealers of the Glass-Steagall Act?" for a bull-bear standoff.

Keep those questions and comments coming
As individual investors, we all have a material interest in how President Obama's new rules of the road will affect our portfolios, the financial products and services we use, and the companies in which we invest.

We are committed to keeping our conversation with the administration going and representing you, our community of Fools: Enter your comments below about financial-regulation reform and what changes you, as an individual investor, want the administration to make.

Tomorrow on, we talk with Goolsbee about "too big to fail," banks that have become even bigger post-crisis, and how the administration views the present state of the banking industry.

Further Foolishness: columnist Dayana Yochim does her banking and brokering at separate institutions, a la Glass-Steagall. The Motley Fool is investors writing for investors.

Read/Post Comments (6) | Recommend This Article (24)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 19, 2009, at 7:16 PM, busterbuddy wrote:

    Shareholders have no rights by the factor of the size of companies stock. Even Vanguard if it voted is shares against management could not make much of an impact. The true strength of capitalism is that is works best in a republic based on democracy where the people institute rules for capitalism to play by. This foolishness of thinking, "oh the markets can't be controlled is just wrong".

    So the repeal of Glass-Steagall was a mistake and did contribute to the problems, it is not the only reason. Glass-Steagall was going to have to change unfortunate for eveyone, including middle class European's, the investment banks hiding as banks robbed people utilizing high yielding CDs and CDOs that Investment banks created. If you can't place your money in the bank and not worry about someone robbing it then it is best to invest in Gold and Silver and put it under the bed.

    Unfortunate for America and the world we elected someone who talks good and appeals to your marketing sense and not to your common senses.

    My view is last year was the first shot, something might happen with the next tens years to cause us to think, ok everything is ok. But within 20 years the world is going to see the completion of this financial crisis. Want to see the pattern. Ready Financial history from 1900 to 1929. House of Morgan supposedly save US during Teddy's R. Presidency. But the foundations were set that resulted in the depression. And the final decision by the Federal Reserve to control money supply.

    Sooner or later control of money supply is coming and it will come at the wrong time for most.

    You much always, always keep the investment banks out of the commercial banks. Always. Always. Or the investment banks will steal your money. Goldman Sach's is still alive and profiting. Wonder why? Because they stole your money, legally. But they stoled it never the less. If the king makes it legal to steal is it still wrong?

  • Report this Comment On October 19, 2009, at 7:33 PM, xetn wrote:

    It seems to me you should be looking at who stands to benefit from this new proposed legislation because you can bet it will not be the individual investor. It will be one of several large companies, perhaps a-la GS, who will reap billions from this. In the end, almost every bit of regulation benefits a few at the expense of everyone else.

    Just look at the Chinese tire tariffs just imposed by Obama. Just who do you think is benefiting from that?

    The labor unions at the expense of all consumers in the US who now have to pay much higher prices for their tires.

    Fool On!

  • Report this Comment On October 19, 2009, at 10:49 PM, thisislabor wrote:

    you, forget it, I just don't want to retype the same thing.

  • Report this Comment On October 19, 2009, at 11:17 PM, weforgot wrote:

    Credit Default Swaps - According to the New York State Insurance Commissioner, "Credit Default Swaps" were considered insurance and regulattion was passed in 1908(?) by New York state because they had the same probelem back in 1908 that we had With Credit Default Swaps in 2007-2009, except they called them something else in 1908.

    If my memory is correct, in his testimony to Congress the Insurance Commssioner for New York State stated that Congress passed a law in 2002 stating that the Credit Default Swaps were not insurance and the states could not regulate the companies that sold Credit Default Swaps. ( Oh, with the brains in Congress we are Doomed to repeat this over and over.)

    It is my understand, from what I have read, that the Credit Default Swaps issue by AIG required the U.S. tax payer to put up over $180 billion. The Credit Default Swaps sold to investors by AIG were insurance against losses from investing in the mortgage derivatives backed by the subprime loans.

    Why are we not hearing more about this???

    We Forgot that the History of Greed repeats its self when greed is left to operate unregulated.

    The dividsion of AIG that sold the Credit Default Swaps and got huges bonuses are the same as Bernie Madoff. The U.S. taxpayer picked up the pieces of that Ponzi scheme promoted by AIG.

  • Report this Comment On October 20, 2009, at 1:59 PM, jimhwall wrote:

    What really failed was the role of the external auditor signing off on financial statements. As long as they are paid by the company they are auditing there is a conflict of interest.

    A hudge improvement would be public companies pay into a fund which then pays external auditors and audit reports/findings are made public.

    Another hudge improvement would happen indirectly because then each company would greating improve their internal audit staff to find and fix stuff before the external audit staff does.

  • Report this Comment On October 26, 2009, at 8:25 PM, stocksandbombs wrote:

    Wow, I am disappointed in this Goolsbee character. Seems slimy. Worse, he seems to lack good judgment.

    Setting aside arguments over whether or not GS was a good idea, I would focus on the fact that it was a simple, clear idea. When Gool goes right into how GS was complex he's wrong -- or lying. Whatever. But then as he talks about some sort of real-time regulatory council deciding on things as they arise my blood boils. Why can't people see how stupid this is? Everyone knows that economics happen OVER TIME; to think you can spot problems and correct them as they arise is foolish, in a bad way!

    One more thought: today's financial companies are not Too Big To Fail, they are To Big To Succeed. How can one company be expert at banking, brokering, research, insurance and retail? And even if it could be expert in all these areas, the conflicts of interest are insurmountable.

    We're all doomed.

    Jeff Shattuck

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