Category: Aggregated

Frequently Asked Questions

Wasn’t the repeal of Glass-Steagall irrelevant to the 2008 financial crash, because the crash was triggered by the failures of financial firms which were not combined monsters (banking/investment, banking/securities, broker-dealing/insurance, underwriting), but were stand-alone monsters like Bear Stearns and Lehman Brothers investment firms, AIG Insurance, etc.? Glass-Steagall would not have been regulating these firms anyway.

This is the argument of choice for Wall Street, President Obama, the authors of the Dodd-Frank Act which blocked the restoration of Glass-Steagall after the crash, conservatives and liberals alike who lobby for Wall Street, etc.

1) This argument is absurd on its face, because the big financial firms that failed in 2007-08 were simply those that were not bailed out by the Federal government.

That is all that determined it. Federal Reserve Chairman Ben Bernanke himself told the Financial Crisis Investigative Commission in 2011, that 11 of the 12 biggest banks had been insolvent in October 2008; they would have failed without the TARP bailout by the Treasury and the abundant bailouts by the Federal Reserve and FDIC. These banks would never have become as large and unmanageably complex as they were, if Glass-Steagall had not been eliminated in the 1990s.

In fact, the most dangerous of all the banks in the 2008 crash was one that didn’t go bankrupt—Citigroup—because it received by far the biggest bailout in history by the TARP ($45 billion), the FDIC ($340 billion in asset guarantees) and the Federal Reserve (hundreds of billions in revolving, no-cost liquidity loans starting in 2007). The FDIC Chair, Sheila Bair, later wrote, “If you wanted to make a definitive list of all the bad practices that had led to the crisis, all you had to do was look at Citi’s financial strategies.”

2) That shows that the argument is absurd. But what shows that Glass-Steagall, if it had remained in effect and enforced, would have prevented the 2008 financial crash?

The simplest “proof” is the case of the Long-Term Capital Management (LTCM) hedge fund. By 1995, when Fed Chair Alan Greenspan had essentially finished emasculating Glass-Steagall, large commercial deposit banks could have up to 25% of their assets in securities speculations or derivatives, and/or in loans to non-bank financial firms which did nothing but such speculation. Glass-Steagall had stopped such conduct by commercial banks for 55 years. From 1995 until 1999, fifty-five banks had made loans to one notorious hedge fund—LTCM—dealing entirely in derivatives. LTCM had borrowed capital totaling 100 times its own capital; i.e., it was leveraged 100:1 by the big banks of the world. And when it failed in early 1999, this single hedge fund nearly caused a global financial panic – Greenspan had to call an emergency meeting of all the biggest banks and arrange an emergency bailout of LTCM.

Under Glass-Steagall from 1933-95, the U.S. commercial banking sector proliferated into many thousands of regional and community banks, with no global giants until the past 20 years. There were many failures of financial firms, but none of them spread into bank panics like Lehman Brothers in 2008—or like LTCM would have caused already in 1999.

Before Glass-Steagall, many banks had thrown their deposit bases into stock market speculations. After Glass-Steagall was eliminated, they did it again, on a much larger scale, and with much more complex bond market speculations and the financial derivatives casino. The banking system dramatically changed without Glass-Steagall separation regulations. The largest banks became impossibly complex, going from typically 1-300 subsidiaries to typically 2,500-4,000 subsidiaries, buying and creating what were overwhelmingly securities and broker-dealer vehicles. The derivatives markets exploded geometrically with the flow from depository giants, from about $70 trillion notional value of derivatives in 1997 to $700 trillion in 2007 according to the Bank for International Settlements. The largest banks became entirely interconnected with one another and with investment banks and “shadow banks” like hedge funds and private equity funds—particularly through their mutual derivatives exposures. The big banks’ leverage ratios were allowed to rise from typically 16:1, to 30-35:1.

Within less than a decade after the repeal of Glass-Steagall, every large “shadow bank” or monoline insurance company was a potential “LTCM.” If even a very large hedge fund blew up, everything would blow up. Bear Stearns would have done the trick but it was bailed out by the Federal Reserve, which [completely against its own regulations] bought $30 billion of Bear Stearns’ assets with printed money. Lehman Brothers did the trick because the Federal government did not bail it out. Under the Glass-Steagall regime, large investment firms could fail, like Solomon Brothers or Drexel Burnham Lambert, without causing bank panics, because the large commercial banks were separated—by Glass-Steagall – from their business of securities speculation.

Would restoring Glass-Steagall reduce the political power of the Wall Street banks?

There is no substitute for prosecuting the top executives of the major Wall Street banks for the endless catalog of criminal actions they’ve been exposed in – fines, even large fines, do not reduce these banks’ political power.

But restoring Glass-Steagall would definitely reduce their power. It would lead to the removal of the managements of many of the biggest bank holding companies, whose holdings would be broken up under Glass-Steagall. Secondly, many of the speculative units of these huge banks will go under once the commercial banking units, holding $12 trillion in savings deposits, can no longer be used to support them because of Glass-Steagall separation.

Moreover, the financial sector will again have different sections with different interests to lobby for. Without Glass-Steagall, a Citigroup pursues every speculative investment strategy known to investment banks, hedge funds, money market mutual funds, etc. etc., because it owns them all or buys or backs their securities and derivatives. So all the financial firms push for deregulation of all of it, the whole casino.

Under Glass-Steagall enforcement, commercial banks, investment firms and other funds were often lobbying against each other; in 1971, the mutual funds sued Citibank for trying to steal their turf in violation of Glass-Steagall – as a result, the Supreme Court upheld Glass-Steagall in the strongest terms. Thus the outrageous current power of the financial industry, acting through universal lobby groups like the Securities Industries Association, will be broken up.