The nascent Occupy Wall Street movement in the United States has drawn widespread attention to the domain of financial regulation. Protesters in the streets insist that the financial sector become subject to the demands of the vox populi; among the most commonly mentioned proposals of Occupy Wall Street is that the United States “reinstate the Glass-Steagall Act of 1933.”
The 1933 Glass-Steagall Act contained a number of provisions relating to the financial sector, some of which, like a provision allowing the government to set interest rates in savings accounts, or provisions forbidding most instances of interstate branching, were repealed in the subsequent seven decades, others of which, like the existence of a Federal Deposit Insurance Corporation (FDIC) to insure bank deposits, persist in one form or another. Contemporary advocates of Glass-Steagall reinstitution are, in almost all circumstances, referring to the provision that prohibited deposit-holding banks from existing under the same ownership structure as other financial companies; this provision was overturned in 1999 by the Gramm-Leach-Blilely Act.
Many perceive the Gramm-Leach-Bliley Act to have been a cause of the 2007 financial crisis, drawing a causal link between Gramm-Leach-Bliley and increased levels of systemic risk throughout the financial sector. By allowing “commercial banks” and “investment banks” to merge, Gramm-Leach-Bliley helped create the “too-big-to-fail” bank, while simultaneously setting up commercial banks that were actually risky enough to fail.
(1) Plenty of people realized that repealing Glass-Steagall was a terrible idea
To be more specific, virtually every Democrat in the Senate realized repealing Glass-Steagall was a terrible idea. In 1999, of the 45 Democrats in the Senate, only 1 voted for Gramm-Leach-Bliley (44 voted against it).
Occupiers and others looking for continued change to the financial sector should take heart–you have more allies than you realize.
(2) The Volcker Rule addresses some of the problem, but keeps the U.S. economy exposed to considerable risk
The Volcker Rule, implemented as part of Dodd-Frank in 2010, like Glass-Steagall, attempted to distance commercial banking from investment banking, but the distance imposed is not as great as it was under Glass-Steagall. Depository institutions remain able to engage in a fairly wide variety of investment banking activities, but are forbidden from engaging in “nonbanking activities,” particularly proprietary trading (having their own portfolios that they are trying to make money on in the market), hedge fund management, and under the similar Lincoln Amendment, also under the Dodd-Frank Act, from engaging in commodity trading.
(3) The groups that lobbied the hardest for Gramm-Leach-Bliley were also some of the groups that lost the most in the financial crisis
The two best examples of financial institutions “created” out of GLB are Bank of America and Citigroup.
The case study of Citigroup offers a unique look into the impacts that Gramm-Leach-Bliley had on increasing systemic risk. Ironically, Citigroup (then Citibanks’s) lobbying efforts played an important role in the initial passage of Gramm-Leach-Bliley; they hoped to merge with Traveler’s Insurance and accordingly, donated $720,000 to political candidates during the 1998 election cycle, an unprecedented amount in donations during a non-presidential election for Citibank at the time (Grant 400). The architects of the universal banking strategy in the United States, they would also become a living example of the dangers of a universal banking model. Between 2006 and 2009, Citigroup would lose over $250 billion in value, but their troubles did not per say originate in the financial crisis. While Citigroup’s strategy of cross-selling was successful with institutional clients, it notably failed to gain traction at the consumer level; in an effort to boost earnings after disappointments in consolidation, Citigroup began to substantially increase its risk portfolio, ultimately putting their institution’s solvency on the line, and becoming the market leader in CDOs (Grant 401). TARP occurred in October of the 2008, but this was not the last of cash infusions for Citigroup, whose decline became most apparent “late in the game” relative to other financial institutions. The government ensured over $300 billion of Citigroup’s assets in 2008, and in February of 2009, the United States government took a 36% equity stake in Citigroup (Grant 404). Gramm-Leach-Bliley had resulted in financial institutions, like Citigroup, too big to manage themselves, and too big to fail. The risk levels held by Citigroup and other financial institutions as a result of their proprietary trading not only directly influenced their solvency, but contributed to liquidity crisis; an awareness that other parties held toxic equity or belief that they may hold toxic equity contributed to the degree of inter-financial-institution-distrust that brought lending to a halt