Stop Blaming Gramm-Leach-Bliley

Frank Rich warns of the "Best and the Brightest" in his NYTimes column today. He is particularly concerned about the economic team's potential for hubris, which is all well and good. However, he throws the repeal of Glass-Steagall in as if everybody agrees that was a terrible move:

That a Hydra-headed banking monster like Citigroup came to be in the first place was a direct byproduct of deregulation championed by Rubin and Summers in Clinton’s Treasury Department (where Geithner also served). The New Deal reform they helped repeal, the Glass-Steagall Act, had been enacted in 1933 in part because Citigroup’s ancestor, National City Bank, had imploded after repackaging bad loans as toxic securities in the go-go 1920s.

In truth, I haven't seen anybody make a compelling case that repealing Glass-Steagall was the cause of our problems. Indeed, I can't find anybody who says it that doesn't just assert it was a mistake prima facie or through some stretched analogy to the 1920s-30s.

As far as I can tell, the repeal of Glass-Steagall has helped. Perhaps a brief explanation is in order.

There are three types of banks:

• Investment Banks
• Retail Banks
• Universal Banks

Investment banks underwrite securities and bonds. They usually trade in the markets themselves. It is a high risk, high reward type of banking.

Retail banks, as the name implies, have branches that accept deposits.

Universal banks are both retail and investment banks.

Glass-Steagall drew a bright line between investment and retail banking. Therefore, it banned universal banks. It was repealed in 1999 when the Gramm-Leach-Bliley Act passed into law.

What caused the credit crunch was that people believed financial engineering was in fact financial alchemy. That they could turn junk into gold. And it sure seemed that way as long as the houses kept going up. Since everybody believed that the junk was in fact gold, they bought it. The banks that really failed in this whole thing were the investment banks. Bear Stearns and Lehmans Brothers were investment banks. That JPMorgan Chase could only buy Bear Stearns to try to save the economy because Glass-Steagall had been repealed seems to be overlooked. Likewise, Bank of America could only buy Merrill Lynch because Glass-Steagall had been repealed. We have been encouraging retail banks to buy investment banks, ie the creation of universal banks, to thwart the worst of this crisis. This runs entirely contrary to Glass-Steagall.

I have seen no compelling case that Glass-Steagall caused the problems, but there is direct evidence that the repeal of Glass-Steagall helped. My theory for why people keep mumbling shit about Glass-Steagall is two fold. First, it sounds sophisticated. They want to sound like they understand this shit when the don't. "It was the repeal of Glass-Steagall," they say. Everybody else, who has as little idea as the other person, tut-tuts, "yes, yes, Glass-Steagall." Second, they are convinced lack of regulation was the problem, and therefore are convinced, since they don't understand this shit anyway, that we should go back to a state of regulation before the crisis, which is just stupid. Because as some economists like to say, when you run somebody over the solution isn't often to put the car in reverse and do it again. Not all deregulation was bad, and not all proposed regulation will be good.