Thomas E. Augustyn
Iowa School of Banking
2009 Intersession Project
There is one legislative issue which will be ultimately responsible for the future direction and degree of bank regulation. This issue is the management/regulation of the financial services industry that contains “systemically relevant” (aka “too big to fail”) firms. Management & regulation goals must be 3-pronged:
1. It must be strong enough to prevent the failure of “systemically relevant” firms (without artificial outside support)or provide for a less-traumatic winding down of a “systemically relevant” firm.
2. It must prevent the emergence of more “too big to fail” firms
3. It ...view middle of the document...
The current financial crisis is frequently called the worst since the Great Depression. And Gramm-Leach-Bliley is often cited as a cause, even by some of its onetime supporters.Yet the criticism is often vague, which means that anyone trying to understand the causal chain — how the end of Glass-Steagall led to the end of Lehman Brothers — will have a hard time doing so. To many banking experts, the reason is simple enough: namely, that the law didn’t really do much to create the current crisis. It is a handy scapegoat, since it’s easily the biggest piece of financial deregulation in recent decades. But one act of deregulation, even a big one, and the absence of other, good regulations aren’t the same thing. The root of the current crisis isn’t so much what Washington did, in other words, as what it didn’t do.
The point of Gramm-Leach-Bliley was to tear down restrictions, built by Glass-Steagall, separating banks that did risky investing from those that did basic lending. (The mingling of those two helped create a cascade of bank failures during the Depression.) Thus were born Citigroup, Bank of America and J. P. Morgan Chase, behemoths that owned bank branches, bought and sold stocks and shepherded corporate mergers.
But what else do those firms have in common today? They weren’t the ones that imploded, at least not first. While hardly unscathed, some of them are emerging as survivors amidst the wreckage. The first fatalities were firms that didn’t change all that much in the wake of Gramm-Leach-Bliley. Until their dying day, Bear Stearns and Lehman Brothers were both classic investment banks.
They got in trouble by making a series of risky new bets while Washington did nothing new to stand in the way. “What you’ve got,” said Robert Barbera, a Wall Street economist, “is a system that has gone wildly beyond the safety nets that were in place.” Financial firms chopped bad mortgages into thousands of little pieces and deluded themselves into thinking that the sum of the parts was safer than the whole.
Gramm-Leach-Bliley isn’t entirely blameless. For one thing, the mergers it encouraged left banks with more capital to invest; some of the capital ended up in that deluded subprime mortgage market. But the law doesn’t deserve the mythical importance it’s now accumulating.
Who, then, in Washington, is to blame? As it happens, it’s many of the same people who were behind Gramm-Leach-Bliley. The Clinton administration and Congressional Republicans failed to create a strong framework in place of Glass-Steagall. Democrats pushed for riskier mortgage lending, in an effort to expand home ownership. But surely the bulk of the blame lies with the policy makers and regulators who were on duty while the housing bubble inflated and Wall Street went wild — the Bush administration and Alan Greenspan’s Federal Reserve. Their near-religious belief in the powers of the market led them to conclude that the mere fact that a company was...