Glass-Steagall: Not the Answer to Our Financial Woes

The Glass-Steagall Act of 1933 was created to make sure average citizens' savings were not lost in investment banks' mistakes. The act lasted for decades, but was repealed in the '90s after tremendous lobbying from Wall Street. Since the financial crisis of 2008, there have been voices from across the board calling for the reinstatement of Glass-Steagall. The only problem is, the legislation wouldn't have prevented the financial crisis of 2008, and it won't prevent another one.

The situation
Without making this too much of a history lesson, let's define the Glass-Steagall Act in a nutshell as the separation of commercial banks and securities firms. It was effectively a dual banking system: one for loans and traditional banking, and one for investment and securities banking.

The act was officially repealed in 1999 after relentless lobbying, though many considered it to be defunct before the official repeal. In 1998, Citibank and Smith Barney were cleared to become affiliates, prompting President Clinton to declare the Glass-Steagall Act "no longer relevant."

Since then, banks consolidated into the "too-big-to-fail" organizations we see today. After the financial crisis, lawmakers, pundits, and anyone with a keyboard touted the reinstatement of Glass-Steagall as the answer to the issues facing our banks. There are some merits to reinstating the laws, but not as pervasive as one might think.

An alternate reality
Let's say Glass-Steagall had been reinstated, or was never even repealed. As Andrew Sorkin said in a New York Times article, Bear Stearns' and Lehman's collapses would still have occurred, as they were strictly investment banks. When Merrill Lynch was taken under Bank of America's (NYSE: BAC  ) wing, it, too, was only an investment bank and would not have been saved by Glass-Steagall. The biggest bailout member, AIG (NYSE: AIG  ) , was an insurance company, an industry not even mentioned in the legislation. You see my point.

Yes, the commercial banks were involved in complex derivatives and a series of other things they should have never touched, but it wasn't what created the collapse. Bank of America's biggest mistake was buying Countrywide Financial, an event now being touted as "the worst deal in the history of American finance." So even if Glass-Steagall had been around for these events, it doesn't look like things would have turned out much differently.

An answer?
None of what I have said is trying to suggest that no change is needed or warranted. I would be the first to agree that big banking has become an uncontrollable monster, something even CEOs cannot manage. When I speak with friends from Citigroup (NYSE: C  ) or Bank of America, they are in awe of their companies' sheer size and scale. How could something so bloated ever be controlled, especially by one person?

It's with that in mind that I don't blame Jamie Dimon for the massive trading losses at JPMorgan (NYSE: JPM  ) . Yes, it was a poor decision fueled by greed and then fear, but can Dimon be expected to stay on top of every issue concerning a $130 billion company with 260,000 employees around the world? Understand, I am not exonerating anyone from wrongdoing, but I believe there needs to be clarification regarding the beasts with which we are dealing.

Greater executive oversight will improve the transparency of public companies and ultimately aid shareholders and Main Street. Banning black-box trading would give power back to the average trader (though I think investors are basically immune from this practice to begin with). Contingency plans for the big banks will give the country an idea of what will happen if too-big-to-fail fails. But none of these things will prevent financial crisis 2.0. Patchwork does not cure systemic error.

Sort of
The answer to our nation's financial woes begins far away from Wall Street and the White House. It involves every single person in this country. It is the most difficult of all the answers, because it requires genuine change, a change in philosophy. As a recent Internet meme stated: "To blame free markets for the failures of crony capitalism is like hating love because of the existence of adultery."

What needs to change is us. We created the systems that drive the world, and the systems are not flawed. We just aren't using them the way we're supposed to. We must learn that homeownership is not an American ideal; it's just another option. We need to see that credit cards are not easy ways of getting new toys, but instead high-interest lending machines. When we treat our financial system with the respect it requires, we'll see fewer crises.

The goal of free markets is to drive innovation and create an exchange where each party brings their trade to the table. It's a system that benefits all who participate, and ultimately furthers the nation, not just the 1%.

Duh
I realize these are not novel ideas, and I realize this is idealism at its best (or worst). I don't expect these things to happen, but I also don't expect the problems facing us today to be fixed in any meaningful manner.

We must first learn that recycling legislation or creating new rules is not the answer. Only from there can real change begin.

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Fool contributor Michael Lewis owns none of the stocks mentioned in this article. You can follow him on Twitter @mikeylewy. The Motley Fool owns shares of JPMorgan Chase, Bank of America, and Citigroup. Motley Fool newsletter services have recommended buying shares of American International Group. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (5) | Recommend This Article (5)

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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 July 11, 2012, at 4:09 PM, Arde5643 wrote:

    Just from scanning through history books, or reading sociology/psychology books, it should be obvious that it's impossible for individuals to suppress the need for more.

    It's the drive for the improvement of society and unfortunately the decline of humanity as well.

    What they can do, however, is to create rules in place that will guide such need for the betterment of society.

  • Report this Comment On July 11, 2012, at 5:33 PM, rtichy wrote:

    I'm not sure at all that it's clear that Lehman Bros. would have failed with Glass-Steagall in effect; it's like envisioning a complete alternate reality-- you cannot just evaluate whether the act barred the kinds of losses incurred at Lehman-- you have to envision a place where Lehman's competition didn't include the "regular" banks, who were driving down the returns on the area of investment Lehman had dealt in previously, causing Lehman to chase higher returns in higher risk areas.

    Well regulated capital markets are part of what the 20th century belong to the United States, even if regulation prevented certain individuals and companies from grabbing huge slices of the global pie.

  • Report this Comment On July 11, 2012, at 5:33 PM, rtichy wrote:

    "...what [made] the 20th..."

  • Report this Comment On July 11, 2012, at 10:30 PM, Sketch71 wrote:

    You didn't convince me; I agree with rtichy: you're basically using an "all other things being equal" argument that does not address any of the myriad other factors that collectively allowed the crisis. All other things would NOT have been equal, and I'm still convinced that Glass-Steagall would have prevented and/or significantly reduced some/many of those other factors.

  • Report this Comment On July 12, 2012, at 9:20 PM, JohnMiller15 wrote:

    Lehman, etc. wouldn't have existed in such a scale without the repeal of Glass-Steagall. And, as such, we wouldn't have cared and had to bail them out.

    There was an unspoken and effective understanding that:

    1. Banks could use depositors money for risky investments and

    2. At a certain size, they would have to be bailed out by Treasury

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