¿Why is the repeal of Glass Steagal in 1999 blamed for the surge of derivatives and the crisis?

Economics Economics Questions
1

I have searched but I have not found an answer. If it has been discussed, someone point me to the thread, thanks.

I am studying the Basels I accord, and it seems that the securitization process was promoted by it. That led me to questioning what I was hearing about blaming the repeal of Glass Steagal Act by the Clinton administration in 1999, known as the Gramm-Leach-Biliey Act.

I have been studying the issue this afternoon and I dont see how the repeal of Glass-Stegal act caused, even in part, the crisis, but since I am still studying the monetary system, I would like to hear opinions in the issue.

There are two main criticisms of the Gramm-Leach-Biliey Act, but only one has to do directly with repealing what was left of the Glass-Stegal Act (it had been reduced alredy by 1980 and 1982).

  1. I am going to start with the less popular accussation, since it seems easy to disproof. It is basically the repeal of the Glass Steagal act that, allowed banks to become commercial and investing banks at the same time. Glass-Stegal did not allowed this.

It seems easy to disproof, since the “non-mixed” banks (the ones Glass-Stegal allowed, Lehman, Bearn Sterns,…) have had a lot more problems during the crisis, than the “mixed” ones (the ones Glass-Stegal did not allow). So it could be even said that allowing banks to diversify even helped.

  1. This is the most used argument, and it says that Gramm-Leach-Bliley Act removed suppervision of security-based swap agreements by the SEC, and this unregulated section of the market led to the incredible and dangerous growth of the derivative market. But Phil Gramm, claims that it did not unregulate anything, but just moved the regulatory power from the SEC to the Fed (not that I trust any of them, but still, it would not be a unregulated market).

Also, I have found an article on the Mises Institute, claiming that, under a fiat monetary system, the repeal of Glass-Steagal was corporate welfare. But I have read the article and its not very specific in this point, it just names it and little more. The article is this one: http://mises.org/daily/3098

I am looking for criticism, other points of view, etc… because from what I am learning it seems to me that the Gramm-Leach-Bliley Act is taking blame because of political propaganda, but in reality it has little to do with the real problems that caused this crisis.

2

Repeal allowed a banking approach where basically commercial and investment banking were separated under the assumption that the two had conflicting interests. Repeal allowed commercial lenders to get into the investment side of things and pretty soon structured products like the mortgage backed securities appeared. Then blammo, it all went to shit.

It’s also an incomplete analysis. Repeal of Glass Steagall may have facilitated the creation of bad debt, it doesn’t explain why everyone was buying it and where they got the money to do so.

3

But structured products, derivatives, existed way before 1999, when Glass Steagal act was repealed. How exactly did repealing the separation between comercial and investment banks suposedly made the derivative market grow?

4

Glass Steagall is such a red herring because you miss the forest for the trees.

In general, two people performing a voluntary transaction have no direct effect on others. So why should we disallow it again?

In other words, why can’t banks create financial products and sell it to others? Why can’t people make bets and swap derivatives? No one ever explains. It’s always mumbling about the entire system failing. Of course, that’s the entire point. If the current market structure - largely created by government - is unsustainable and freedom in some areas causes the superstructure to fall over, then it needs to fall over.

5

Here’s one thread about it.

https://forum.freecapitalists.org/t/glass-steagall-act/11067

It has a link to a Lew Rockwell article written in 1993 predicting it all.

There are other thread about it as well. You have to search by using google. Yes, the google search is far superior to the one on this site. This is very common.

You type into the google box the following: site:mises.org/Community/forums glass steagall

Good luck!

6

Thanks. I just finished reading the article and I have read a bunch of other threads about Glass Steagal from the forum (I should have figured out myself that I could use google to search).

The point is that everybody is talking about the fact that now investment and commercial banks can join in one company while before they could not (point 1 in my original post). But I think this is a nonissue since time has showed that the “mixed banks”, the ones Glass Stegal did not allowed have gone through the crisis better than the “non-mixed banks”, the ones Glass Steagal did allow. So one could say diversification was a good thing.

What I am really interested and nobody talks about is the second point: where the regulatory powers over credit swaps were taken from the SEC to the Fed. I dont see how that accounts as de-regulating and also, I dont see no difference by some market being regulated by the SEC or by the Fed. I think both are useless and corrupt institutions.

I think Basels I was one of the reasons for the growth of derivatives. Attacking the 1999 bill that repealed Glass-Steagal and other things seems to me like political propaganda. But I want more opinions on this, on the second point.

7

" I dont see how that accounts as de-regulating"

“De-regulation” as commonly used doesn’t actually mean de-regulation. It means whatever the person using it wants it to mean. Usually it means, “new regulations more in line with what my particular special interests paid me to achieve.”

For Democrats it means, “Any legislation proposed by a Republican.”

For Republicans it means, “I’m a better central planner than the previous administration.”

For the general public it means, “Any change in existing regulations that I don’t understand.”

Those are the four most common definitions to my knowledge.

8

I believe one could look at the repeal of Glass-Steagall and its results as another problem caused by the government and its regulations. With the repeal of the legislation, it allowed for banks to undertake risker investments, however they are basically underwrit by the taxayer through such things as the FDIC and the like. This allowed for them to ‘privatize the profit and socialize the losses’ so to speak. Robert Higgs talks about this in a debate he had with James Galbraith on Scott Horton’s radio show http://www.scotthortonshow.com/2010/04/21/antiwar-radio-robert-higgs-vs-james-galbraith/

9

](http://www.scotthortonshow.com/2010/04/21/antiwar-radio-robert-higgs-vs-james-galbraith/)

Thanks, I can not listen the audio right now but I will later.

So let me repeat to see if I understood what you are saying correctly. FDIC insures commercial banks but not investment banks, but since now the same institution can be both a commercial bank and an investment bank, the FDIC can be implicity guaranteing an investment bank, and because of that it can led these banks to invest more recklessly because they are insured by FDIC. Am I getting your argument correctly?

It makes sense, but then it does not explain why investment only banks (as allowed by the Glass Steagal Act) like Lehman or Beran Sterns have been the banks that were in worst shape during the crisis, and “mixed banks” (the ones not allowed by Glass Steagal Act) are in better shape. If your argument is correct it should be the other way arround.

10

Indeed you do have what I was trying to convey right. As to why pure investment banks where worse hit in the recession rather than the mixed banks I would imagine that the ‘mixed firms’ had more assets in things other then housing etc. and could take the loss better then the investment banks which more or less followed the boom cycle in a more total way, however I cannot say that with any authority. I am sorry that I am not more knowledgeable on the specifics of the banks assets etc.

11

Ok.

The only part that I am missing to answer is wether the allegations of Senator Gramm are correct or are just a lie to dodge responsability. The Senator Gramm claims that he did not deregulated the securities-based swaps, as some claim, (and that would be a change to the Securities Act of 1933 and 1934 and not to the Glass Steagal Act of 1933). The Senator claims that what the Gramm-Hills-Bliley Act of 1999 did change the regulatory powers over the securities-based swaps from the SEC to the Fed.

Can anyone confirm wether he is right or he is lying?

Thanks all for the help.

12

Without the Glass Steagall it was much easier and faster to inflate the bubble. I believe even if it wasn’t repealed the bubble would have arrived but at a lower and less damageable phase.

xahrx wrote the following post at Tue, May 25 2010 3:17 PM:

Repeal allowed a banking approach where basically commercial and investment banking were separated under the assumption that the two had conflicting interests. Repeal allowed commercial lenders to get into the investment side of things and pretty soon structured products like the mortgage backed securities appeared. Then blammo, it all went to shit.

It’s also an incomplete analysis. Repeal of Glass Steagall may have facilitated the creation of bad debt, it doesn’t explain why everyone was buying it and where they got the money to do so.

13

Can you expand on exactly why repealing the separation between investment and commertial bank helped inflate the bubble faster?

14

I would but I don’t have time but allow me to give two powerful reasons:

1- Commercial banks are easier to inflate than commercial ones.

2- Investment banks are driven mostly by equity instead of debt…this link is weaken at least if not broken by repealing the act.

15

Well, if you have time and want to expand, feel free. I am very interested on the issue.