June 16th marked the 85th anniversary of the Banking Act of 1933, known as the Glass-Steagall Act, which separated commercial and investment banking. The Depression-era bank regulation kept different types of financial institutions separate.
But collective memories have waned as to why it was put into law in 1933 in the first place and why it was repealed in part in 1999 by the Gramm-Leach-Bliley Act (GBLA).
More than a few experts have argued that the GLBA’s repeal of the affiliation restrictions of the Glass–Steagall Act was an important cause of the financial crisis of 2008. Economics Nobel Prize laureate Joseph Stiglitz, argued that “when the repeal of Glass-Steagall brought investment and commercial banks together, the investment-bank culture came out on top.”
In an August 11th 2015 interview in INC. magazine, President Bill Clinton publicly declared “the Glass–Steagall law is no longer appropriate.” He said, “There’s not a single, solitary example that signing the bill to end Glass-Steagall had anything to do with the financial crash.” (As quoted in a Politifact article)
But there are many who vehemently disagree with President Clinton’s comment. And many who are very concerned about the direction increased deregulation is taking.
As a recent article posted in Harper asked, “Wouldn’t it be wise to move to insulate the commercial banking sector from another fiasco before the next crisis? Are the White House and Congress ready to act or are we heading blindly to a replay of 2008?”
I would argue that no, we are not heading blindly into a replay of 2008 but instead headed with eyes wide open into another financial crisis. We are ignoring the safeguards that were put in place after the crash of 1929 and those put in place after 2008 to mitigate yet another financial meltdown.
We are deliberately dismantling those regulations put in place after the crashes to prevent said from recurring and once again allowing Wall Street banks to have a free rein, even though they have proven themselves throughout history as titans of greed and fraud. They have not acted prudently. They have not acted with integrity and once again the desire for profits at all costs is taking us toward a big financial shock.
It is imperative that we learn the lessons from even earlier economic periods. Our country separated banking and commerce activities with the passage of the National Banking Act of 1864. The 1864 Act prohibited nationally chartered commercial banks from direct participation in investment banking activities.
However, in the late 1800’s and early 1900’s investment bankers became closely tied with commercial banks and trust companies, with the banks ultimately becoming much more involved in providing investment banking activities. And it has been noted that even before the 1929 stock market crash there was concern expressed among legislators about permitting commercial banks to again engage in investment activities.
Franklin Delano Roosevelt promised Americans relief. He decried “the ruthless manipulation of professional gamblers and the corporate system” that allowed “a few powerful interests to make industrial cannon fodder of the lives of half the population … There must be an end to a conduct in banking and in business which too often has given to a sacred trust the likeness of callous and wrongdoing.”
Ferdinand Pecora was then appointed chief counsel to the U.S. Senate’s Committee on Banking and Currency and was assigned to probe the causes of the 1929 crash. He led public hearings which became known as the “Pecora Commission,” making front-page news when he called as his first witness Charles Mitchell, who was known as “Sunshine Charlie,” the head of the largest bank in America, National City Bank (now Citigroup).
As described in an article in Smithsonian Magazine, “Pecora revealed that National City had hidden bad loans by packaging them into securities and pawning them off to unwitting investors.”
Does this sound familiar?
From the DOJ/FHFA Report of Investigation, 2015, “Citigroup knowingly and purposefully purchased and securitized loans that did not meet representations and warranties or in many cases were outright fraudulent loans.”
Mr. Pecora also called as witnesses many other key bankers of the day, including J.P.Morgan, Jr., with testimony bringing out other instances of bad loan securitizations and other abuses of the public trust. His hearings coined a new phrase, “banksters” for the finance “gangsters” who had imperiled the nation’s economy, and while the bankers and financiers complained that the theatrics of the Pecora commission would destroy confidence in the U.S. banking system, Senator Burton Wheeler (D-MT) said, “The best way to restore confidence in our banks is to take these crooked presidents out of the banks and treat them the same as we treated Al Capone.”
If banks were worried about the hearings destroying confidence, President Roosevelt said, they “should have thought of that when they did the things that are being exposed now.”
By investigating Wall Street business practices and calling bankers in to testify, Ferdinand Pecora exposed Americans to a world they had no clue existed. And once he did, public outrage led to the reforms that the lords of finance had, until his hearings, been able to stave off.
President Franklin Roosevelt signed Glass-Steagall into law in 1933 which launched a 66-year epoch of relatively sound banking, during which time there were no major financial crashes, as occurred in 1929 and again, after Glass-Steagall’s repeal, in 2008.
Banks would make loans and take deposits, and brokers would be allowed to underwrite and sell securities. However no firm could do both due to conflicts of interest and risks to insured deposits. From 1933 to 1999, there were very few large bank failures and no financial panics comparable to the 2008 financial crisis. The law worked just the way it was intended for quite awhile.
In 1939, Mr. Pecora published Wall Street Under Oath, which offered a dire warning. “Under the surface of the governmental regulation, the same forces that produced the riotous speculative excesses of the ‘wild bull market’ of 1929 still give evidence of their existence and influence.… It cannot be doubted that, given a suitable opportunity, they would spring back into pernicious activity.”
Is this prophetic? In 1999 at the behest of the big banks, President Bill Clinton and Sen. Phil Gramm (R-TX) joined forces to repeal Glass-Steagall. This opened the door over the next eight years to the wild, no-holds-barred financial speculation of the 1920s.
Once again, banks originated bad loans and once again they sold them to their customers in the form of securities. Well, as we know, the bubble peaked in 2007 and collapsed in 2008. We lost the hard-earned knowledge of 1933 to arrogance. It was Glass-Steagall that prevented the banks from using insured depositories to underwrite private securities and dump them on their own customers.
According to Demos, a nonpartisan public policy and research organization, the end of Glass-Steagall can been blamed for many of the problems that led to the 2008 financial crisis. “Commercial banks played a crucial role as buyers and sellers of mortgage-backed securities, credit-default swaps and other explosive financial derivatives … Without the watering down and ultimate repeal of Glass-Steagall, the banks would have been barred from most of these activities.” Demos also noted: “The market and appetite for derivatives would then have been far smaller, and Washington might not have felt a need to rescue the institutional victims.”
James Rickards, author of Currency Wars: The Making of the Next Global Crisis, warned us in a 2012 US News opinion piece, “Without the separation of banking and underwriting, it’s just a matter of time before banks repeat their well-honed practice of originating garbage loans and stuffing them down customers’ throats. Congress had the answer in 1933. Congress lost its way in 1999.”
And without a public outcry, such as the Pecora hearings sparked, the writing is definitely on the wall.