Arnold Kling  

Why Not Restore Glass-Steagall?

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David Moss writes,


The fifty years of relative financial calm that followed the Glass-Steagall Act of 1933, the Securities Exchange Act of 1934, and the Banking Act of 1935 strongly suggest that sound public risk management can make a positive difference.

Thanks to James Kwak for the pointer.

If you think that New Deal regulation worked, then why don't you come out in favor of going back to that regulation? If you don't favor going back to New Deal regulation, then why are you claiming that it worked?

Moss and others appear to blame the financial crisis on the repeal of Glass-Steagall. Yet most of them do not argue for restoring Glass-Steagall. No one says that restoring the separation between commercial banking and investment banking would prevent future crises. Hardly anyone even suggests that it would be helpful.

People are not specifically arguing that Glass-Steagall was wonderful regulation. Instead, they are waving around Glass-Steagall in order to make a vague, generic claim that regulation works and deregulation fails.

Beyond this generic "regulation good, deregulation bad" mantra, there is very little that these people have to say that specifically backs up their own regulatory proposals. In contrast, I say that housing policy, securitization, and regulatory capital arbitrage were at the heart of the crisis. I propose changing housing policy to stop trying to use cheap, lenient mortgage credit to promote affordable housing. I propose disconnecting the feeding tube of government support from the mortgage securities market. And I propose attempting to make failure of financial institutions a viable, credible option for regulators. There is a connection between my proposals and what I see as the causes of the crisis.

Moss mostly offers a thermostat theory of financial regulation. Financial regulation is a thermostat, which you can set on "more" or "less." As long as you turn it toward "more," everything will be fine. Never mind what actually caused the crisis (regulatory capital arbitrage) and what was actually irrelevant to the crisis (the erosion of competitive boundaries between commercial and investment banking). Just adjust the regulatory thermostat to "more."


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COMMENTS (6 to date)
DWAnderson writes:

Right on. Your proposals are excellent common sense responses.

The vapidity of 95% of the discussion in the press about deregulation cannot be overemphasized.

Arnold,

Deepak Lal has an interesting hypothesis of why the repeal of Glass-Steagall was counter-productive and it is not about the leftists' deregulation mantra.

Lal's idea is that the repeal of Glass-Steagall increased the moral hazard in the banking system because banks involved in high-risk activities could now avail themselves of the deposit insurance which they previously could not. See here http://www.business-standard.com/india/news/deepak-lalbanking-conundrum/311367/

Do you think Lal's take is valid?

fundamentalist writes:

"The fifty years of relative financial calm that followed the Glass-Steagall Act.."

What about the savings and loan crisis? Also, I remember a financial crisis in the mid-1980's when the price of oil plummeted and oil companies defaulted on their loans. A lot of banks failed. People are always selective in their history when they want to prove a point.

Also, you have to consider that some groups, including the Minneapolis Fed, argued that no crisis existed. A few big banks were in trouble and their CEO's were buddies to Paulson and Bernanke, but some people argue from the data that no systemic crisis existed.

If a crisis existed, it was a crisis of transparency. Banks refused to loan to other banks because no one had any idea which banks were in trouble and which ones weren't. And the Feds insisted on keeping everyone in the dark. Bernanke follows the mushroom policy of management: keep everyone in the dark and cover them with manure.

George writes:

How about this alternate formulation:

'Instead, they are waving around the bloody shirt of Glass-Steagall in order to make a vague, generic claim that regulation works and deregulation fails.'

Don the libertarian Democrat writes:

"Conceptually, I like the idea of creating two sectors, one government insured and highly regulated and the other clearly bearing risk privately. I don't know that the low-risk sector has to be nationalized. But it should be very unattractive to aggressive, go-go managers. The challenge is how you keep the uninsured, less-regulated sector from blowing up in a way that causes widespread problems."

What then did you mean by the point above?

Gu Si Fang writes:

"regulation good, deregulation bad" like its opposite "regulation bad, deregulation good" seems to miss the fact that deregulation consisted of two very different things
1) letting banks chose to whom to lend
2) letting banks chose how much to lend

Is there any reason why we shouldn't have 1) without 2)? This would be like having "good deregulation without bad deregulation". Instead, the choice generally offered is between (1 + 2) or socialized credit.

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