Did You Know Glass-Steagall Would Have Prevented AIG Blowout?

An interesting and fairly thorough argument for the necessity of Glass-Steagall was made in American Banker by Marcus Stanley, the head of the Americans for Financial Reform coalition, in answer to constant debating there and in the Wall Street Journal. While also praising Dodd-Frank in his ending, Stanley observes correctly “the powerful hold that the Glass-Steagall principle of separating commercial and investment banking has on the public imagination. Glass-Steagall has become politically popular for good reason. The public understands that reducing the size and (especially) the complexity of our major publicly supported banking institutions is crucial to a healthier financial system. Restoring some version of the Glass-Stegall firewall between commercial and investment banking is a direct and powerful means to that end. There’s also an understanding that the financial system was generally more stable during the 60 years in which Glass-Steagall was in force.”

Stanley takes on the fig-leaves that Wall Street calls “arguments” against Glass-Steagall restoration.

For example, for those who don’t understand, or deny, that Glass-Steagall would have prevented the 2008 bank panic, he informs that FDR’s law also limited insurance companies. “As Eric Dinallo — the regulator of AIG’s insurance unit — made very clear, it was only due to the repeal of Glass-Steagall that AIG was able to engage in the large-scale credit derivatives business that brought the company down.” AIG would not even have been allowed to buy the Texas thrift bank which it then transferred to London and made into the vastly destructive AIG Financial Products, pouring insurance premium income — illegally, under Glass-Steagall — into AIGFP until it blew out and triggered the TARP bailout. Lehman, meanwhile, had been lying to customers and bond buyers that it enjoyed Federal protection because it had bought — illegally, under Glass-Steagall — two small commercial banks. And Lehman leveraged itself 36:1 on money borrowed from commercial banks in one form or another, especially JPM Chase.

“The 2008 crisis was catastrophic for the global economy not simply because non-bank financial institutions failed, but because the problems in non-banks spread throughout the financial system and threatened to bring down giant megabanks that combined commercial and investment banking, such as Citigroup, JPMorgan Chase and Bank of America. Glass-Steagall firewalls between Wall Street trading markets and ordinary commercial banking are directly relevant to stopping this kind of contagion.”

Finally, Stanley refers to the crucial 2012 studies by the New York Federal Reserve, entitled “Shadow Banking” and “Peeling the Onion: the Structure of Large Bank Holding Companies.” He quotes from the former: “The shadow banking system emerged from the transformation of the largest banks from low return-on-equity (RoE) utilities that originate loans and hold and fund them until maturity with deposits, to high RoE entities that originate loans in order to warehouse and later securitize and distribute them, or retain securitized loans through off-balance sheet asset management vehicles. In conjunction with this transformation, the nature of banking has changed from a credit-risk intensive, deposit-funded process, to a less credit-risk intensive, but more market-risk intensive [i.e, ready to be blow up], wholesale funded process.”

This process, after seven years of zero interest rates and massive artificial liquidity from central banks, has become the dying, non-lending, unprofitable parasites of today’s Wall Street and London giant “banks.”