Hello all, I am a newbie here so please bear with me! I have heard the argument made by some economists that the reason the financial system collapsed was because of deregulation. Most that make this claim cite the Glass Steagall Act being repealed. It is my understanding that this act kept commercial banks and investment banks separate.
My question is, what would have happened had Glass Steagall not been repealed?
The way I understand it, banks still would have been forced to make subprime loans and they still would have been able to package them as MBSs and CDOs and sell them to investment banks. Is this correct? If so, that would mean we still would have had a derivative bubble and it still would have bankrupted investment banks. Is this correct?
The bubble would have been worse, much worse. Banks would not have been able to do the amount of business out of state nor would they have been able to diversify into other businesses. Banks would be even more at the mercy of local trends. If you want proof: Contrast the Savings and Loan Crisis of the 1980s to the one today. In Texas there were a stream of S&L failures because these banks could not get branches out of state. So they made loans to people dependent on the oil business. When oil prices dropped, the foreclosures increased destroying these small institutions.
The large interstate banks in San Francisco and through out California made it through their real estate bust mostly intact. Of course stupid regulators in the Bush Administration and at the Fed forced these banks to over extend themselves to help Goldman Sachs and its friends from crashing. If the govenrment actually listened to the people and did not do the bail outs then these banks would have been in a very good position to make a ton of money from other bank failures.
Thanks for the quick replys guys! Is there ANYTHING behind the claim that Glass Steagall could have helped soften the blow? Usually there is a grain of truth behind most BS haha.
I think, as you pointed out, the real factors that led to the housing bubble were easy money monetary policy and fiscal maneuvers designed to get money in the hands of people that wouldn’t have otherwise been able to get it specifically for the purpose of buying houses. Monetary and credit expansions cause bubbles.
Thanks for the links Dave. I have gone over that thread but haven’t looked at that Lew Rockwell article yet.
Under Glass Steagall would commercial banks have been able to package their mortgages into CDOs and MBSs to sell in investment banks? If so it seems to me not much would be different about the recession. Perhaps it would have been slightly less severe with the commercial banks still somewhat solvent. If not, does anyone have any idea how it would have played out?
This is a great illustration of the calculation problem of a planned economy. Government intervention through regulation and The Fed had perverted the financial incentive structures for so long that even a smart guy like Robert Rubin was unable to foresee the effects of amending existing regulation.