Looking Back at the Repeal of Glass-Steagall, or, How the Banks Caught Casino Fever

If you’ve been reading ND20, you know that the repeal of the Glass-Steagall Act has been a key issue in both understanding the causes of the financial crisis and thinking about how to move forward. Glass-Steagall Act was introduced during the Great Depression, and was repealed in 1999, paving the way for banks to invest in nasty things like mortgage-backed securities and collateralized debt obligations.

As part of our ‘New Agenda for America’ series on the 80th anniversary of the Great Crash, TARP watchdog Elizabeth Warren weighed in on how President Roosevelt and the New Dealers brought innovative ideas to prevent another economic disaster, including Glass-Steagall, which separated banking from high-risk financial speculation (see “The Great Lesson”). Way back in the spring, Rob Johnson, Director of Financial Reform at the Roosevelt Institute, appeared on Al Jazeera to talk about the disastrous impact of doing away with the Glass-Steagall Act (Braintruster Rob Johnson Talks Bailouts to Fault Lines). More recently, Roosevelt Institute Braintruster Bruce Judson argued on this blog that we need an updated “Glass-Steagall 2.0″ that categorizes financial institutions and restricts their activities according (see Glass-Steagall 2.0: The American People Deserve An Explanation).

As our colleagues at Common Dreams point out, today is the 10-year anniversary of Glass-Steagall’s repeal. Robert Weissman writes: “It is an anniversary worth noting for what it teaches us about forestalling financial crises, the consequences of maniacal deregulation, and the out-of-control political power of the megafinancial institutions.”

Weissman notes that Glass-Steagall remained law until 1998, when Citicorp and Travelers Group announced they were merging:

Such a combination of banking and insurance companies was illegal under the Bank Holding Company Act, but was excused due to a loophole that provided a two-year review period of proposed mergers. The merger was premised on the expectation that Glass-Steagall would be repealed. Citigroup’s co-chairs Sandy Weill and John Reed led a swarm of industry executives and lobbyists who trammeled the halls of Congress to make sure a deal was cut. But as the deal-making on the bill moved into its final phase in Fall 1999, fears ran high that the entire exercise would collapse. (Reed now says repeal of Glass-Steagall was a mistake.)

Robert Rubin stepped into the breach. Having recently stepped aside as Treasury Secretary, Rubin was at the time negotiating the terms of his next job as an executive without portfolio at Citigroup. But this was not public knowledge at the time. Deploying the credibility built up as part of what the media had labeled “The Committee to Save the World” (Rubin, Fed Chair Alan Greenspan and then-Deputy Treasury Secretary Lawrence Summers, so named for their interventions in addressing the Asian financial crisis in 1997), Rubin helped broker the final deal.

The Financial Services Modernization Act, also known as the Gramm-Leach-Bliley Act of 1999, formally repealed Glass-Steagall. Among a long list of deregulatory moves large and small over the last two decades, Gramm-Leach-Bliley was the signal piece of financial deregulation.

The result? Casino fever took over commercial banking industry. Weissman quotes Roosevelt Institute Braintruster and Nobel Prize-winner Joseph Stiglitz:

“‘Commercial banks are not supposed to be high-risk ventures; they are supposed to manage other people’s money very conservatively…It is with this understanding that the government agrees to pick up the tab should they fail. Investment banks, on the other hand, have traditionally managed rich people’s money — people who can take bigger risks in order to get bigger returns. When repeal of Glass-Steagall brought investment and commercial banks together, the investment-bank culture came out on top. There was a demand for the kind of high returns that could be obtained only through high leverage and big risk-taking.”

Click here to read the full story, including the four key lessons Weissman identifies from 10 years without  the protections of Glass-Steagall.