All Things in Moderation

I originally posted this in 2008. I meander a little bit. Re-reading it, it sounds like I’m suggesting a lot of things were the result of the Glass-Steagall repeal that were largely unrelated . . . so this argument is flawed. But, I post it as an anchor point for others to advocate a return to Glass-Steagall or to object to any such foolishness. That being said, here it is:

Each time we repeal the Depression era legislation meant to prevent the sorts of collapses we saw in the late 20s/early 30s financial markets, we end up with a financial crisis. Has it ever occurred to those folks that those rules were there for a reason?

In 1933, the Glass-Steagall Act established the Federal Deposit Insurance Corporation, and one very important thing that it did was prevent large private banks–i.e., investment banks–from receiving deposits–i.e., servicing the little guy, and thus end up putting the little guy’s money at risk in speculative corporate and real-estate investments. The idea being to keep investment banks from becoming flush with the savings of middle- and lower-class folks and playing with that money in the marketplace–in no small part to allow for the creation of the FDIC, and keep the government from having to bail out the big investment banks if they ended up losing all their customers’ deposits in the stock market or in real estate speculation.

Between 1933 and 1999–that’s 66 years–we never saw a banking crisis like the one we face now. The closest would be the S&L collapse, and that was in no small part because of a 1982 law letting S&Ls do with their money the sorts of things Glass-Steagall forbade large investment banking firms to do. In 1999, Glass-Steagall was repealed. 8 years later, the financial industry in America is in a mess.

And fixing it doesn’t require a lot of new regulation, or new oversight. There was some corruption here, but most of the mess was made the old-fashioned, completely legal way. The quick fix is pretty simple: Bring Back Glass-Steagall.

Of course, the important issue right now is not how to fix this, but who to blame: Democrats or Republicans? While in the political class they are both blaming each other, the correct people to blame–as it almost always is in this sort of circumstance–is pretty much everybody.

This is a bi-partisan mess. And, certainly, providing incentives to lend to folks with bad credit–out of a misplaced sense of compassion or feeling that too few loans to minorities with poor credit was a sign of racism–was a bad idea. That’s what conservatives are pointing to, and they have a point, but that’s hardly the whole cause of the problem.

Repealing Glass-Steagal was also a very bad idea (and lobbied for by both Democrats and Republicans, and signed by Clinton), because it allows too much intermixing of financial service entities, putting them all in the same leaky boat. Just as the S&Ls failed because they could legally invest in all sorts of crappy investments in order to book short term profits and attract customers with unrealistically high interest rates, allowing investment banks to buy bundled mortgages put both sectors at risk–if the mortgage industry had a crisis, then mortgage companies and investment banks could fail. If the investment banking industry had a crisis, it could mean real problems for the mortgage industry, and so on.

Now, there are lots of other reasons we’re in the subprime crisis. But turning mortgages into vehicles for investment profit that could be sold to investment banks in order to “realize” as-yet-non-existent profits did more to provide incentives to banks and fly-by-night mortgage firms to make risky loans than any requirement that banks serve communities that were poor credit risks. Although that certainly played a part.

There’s a limit to what regulation can do, but requiring consumer loans to be fixed-interest with 10% down, no exceptions, and no “interest free” or balloon mortgages would be one thing that would probably help in the future. The other thing would be to reinstate Glass-Steagall, and make it illegal to sell bundled mortages to investment banks (and book, and award bonuses, on the supposed future profits of these risky loans). Split the lending and investment banking and insurance industries again. Sandbox them, so the crisis in one are much less likely to spill out into all the others.

While they (the banks and insurance companies) lobbied hard to be able to merge all the financial services under one roof (investment banking, consumer banking, insurance), it doesn’t look like that was a very good idea. Additionally, the laws were changed without even a casual glance back at history. When regulations are in place, and the free market has had no need to “correct” for poor performance in the free market, once those regulations are removed, the free market will naturally start building towards a massive “correction”. Which is what happened. Again!

What casual glance back at history could they have made? How about the Saving’s and Loan Crisis? Tightly regulated, with low caps on the interest rates they could offer customers and unable to legally offer credit cards, take ownership positions in real estate, and so on (mostly depression era limitations imposed on them because of the inherent risks), they were low-profit affairs. Then, as high interest rates drove customers away from the S&Ls and into more profitable investments and accounts, the S&Ls suffered–but, at the time, in such a way that put their businesses at risk of failure, but not in a way that would ever have cost the tax payers billions of dollars.

To help the S&Ls remain solvent in face of sky-rocketing interest rates, the Jimmy Carter administration raised the caps that the S&Ls could offer their customers. Not so bad. Then, in 1982, the Garn-St. Germain Depository Institutions Act that apparently helped propel the S&Ls into insolvency while intending to make them more solvent. It was co-sponsored by a Democrat and a Republican, and enjoyed wide house and senate support at the time. Deregulation of this sort always seems to enjoy broad, bi-partisan support. Yet, when the crisis inevitably come, each party points their fingers at the other party and says: “This is your fault!”

What’s odd to me is how hard the financial indsutries lobbied for the repeal of the regulations that, in many ways, protected them, even while preventing them from making money in markets they felt they could serve. S&Ls lobbied for Garn-St. Germain, and the same investment banks and insurance companies that are imploding are some of the ones that lobbied from the repeal of Glass-Steagall. From 1933 (passage of Glass-Steagall) to 1999 (repeal), we never had the sort of the banking and financial problems that cropped up in the space of 8 years. It was almost like they couldn’t wait to commit corporate suicide, and just wanted those pesky regulations that had kept them from doing it out of their way.

Accountability and transparency are important. But firewalls between sectors of the capital markets may not be such a bad idea. While it may limit the profits of banks and insurance companies, it also insulates them against problems that will happen in those markets. And it would be best that if the housing market ever bubbles and collapses again, it doesn’t start taking down investment banks and insurance companies simultaneously. If an insurance company insures a number of banks that hold mortgages, while at the same time investing in bundled mortgages, what’s going to happen when the housing market swings into a down period and foreclosures start happening? That company is going to be hit from both sides. It would be much easier for that company to remain solvent if it insured banks against losses in the mortgage industry, while having the money it draws from to pay out someplace completely out of real estate.

But what’s going to come out of Washington, especially in an election year? Two things. First, lots of pointing fingers and indignant blame from the same people who cooperated in making all this happen in the first place. Second, new regulations (instead of re-instating old one’s that worked) that are designed to protect and prop-up the political class in Washington, rather than being designed to protect the consumer and the small individual with a few bucks in the bank.

Yay, Washington.

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