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Glass-Steagall Act; Anyone understand this ??
Topic Started: Jan 18 2009, 02:23 PM (300 Views)
1hp
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Fulla-Carp
John D'Oh made a statement in another thread that Bush was horribly unlucky. I think he was referring to 9/11, but I think he was unlucky in another way.

If I understand it, in response to banking problems back in the early 1930's the US Government passed the Glass-Steagall Act. This was in response to the banking system collapse in 1933, and not the stock market crash of 1929, and was intended to keep the large investment banks separate from the deposit banks. Not sure I understand why this is important, but it was repealed in 1999 through bipartisan legislature. Of note, the original act established the FDIC.

From Wikipedia, the arguments for and against keeping the ACT intact:


The argument for preserving Glass-Steagall (as written in 1987):

1. Conflicts of interest characterize the granting of credit – lending – and the use of credit – investing – by the same entity, which led to abuses that originally produced the Act

2. Depository institutions possess enormous financial power, by virtue of their control of other people’s money; its extent must be limited to ensure soundness and competition in the market for funds, whether loans or investments.

3. Securities activities can be risky, leading to enormous losses. Such losses could threaten the integrity of deposits. In turn, the Government insures deposits and could be required to pay large sums if depository institutions were to collapse as the result of securities losses.

4. Depository institutions are supposed to be managed to limit risk. Their managers thus may not be conditioned to operate prudently in more speculative securities businesses. An example is the crash of real estate investment trusts sponsored by bank holding companies (in the 1970s and 1980s).

The argument against preserving the Act (as written in 1987):

1. Depository institutions will now operate in “deregulated” financial markets in which distinctions between loans, securities, and deposits are not well drawn. They are losing market shares to securities firms that are not so strictly regulated, and to foreign financial institutions operating without much restriction from the Act.

2. Conflicts of interest can be prevented by enforcing legislation against them, and by separating the lending and credit functions through forming distinctly separate subsidiaries of financial firms.

3. The securities activities that depository institutions are seeking are both low-risk by their very nature, and would reduce the total risk of organizations offering them – by diversification.

4. In much of the rest of the world, depository institutions operate simultaneously and successfully in both banking and securities markets. Lessons learned from their experience can be applied to our national financial structure and regulation.[5]

The repeal enabled commercial lenders such as Citigroup, which was in 1999 then the largest U.S. bank by assets, to underwrite and trade instruments such as mortgage-backed securities and collateralized debt obligations and establish so-called structured investment vehicles, or SIVs, that bought those securities.


What's interesting is the last sentence - does this explain what happened to Citigroup? Was the ground work for the bank failures really setup before Bush came to office, and he just happened to be the unlucky president?
There are 10 kinds of people in this world, those that understand binary and................
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1hp
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Fulla-Carp
A good article from PBS:

Frontline -The Wall Street mess

Greenspan - should have known.

After 12 attempts in 25 years, Congress finally repeals Glass-Steagall, rewarding financial companies for more than 20 years and $300 million worth of lobbying efforts. Supporters hail the change as the long-overdue demise of a Depression-era relic.

So we now have what $300 million bought us. If you read the article you'll recognise most of the names as the companies either in trouble, or no longer around.
There are 10 kinds of people in this world, those that understand binary and................
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Red Rice
HOLY CARP!!!
Makes your blood boil, doesn't it.
Civilisation, I vaguely realized then - and subsequent observation has confirmed the view - could not progress that way. It must have a greater guiding principle to survive. To treat it as a carcase off which each man tears as much as he can for himself, is to stand convicted a brute, fit for nothing better than a jungle existence, which is a death-struggle, leading nowhither. I did not believe that was the human destiny, for Man individually was sane and reasonable, only collectively a fool.

I hope the gunner of that Hun two-seater shot him clean, bullet to heart, and that his plane, on fire, fell like a meteor through the sky he loved. Since he had to end, I hope he ended so. But, oh, the waste! The loss!

- Cecil Lewis
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Mark
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My blood vaporized long ago.
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1hp
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Fulla-Carp
I notice Quirt didn't jump in here to defend Bill Clinton actually signing this failure of a repeal into reality. :bluewink:
There are 10 kinds of people in this world, those that understand binary and................
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ivorythumper
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1hp
Jan 19 2009, 11:46 AM
I notice Quirt didn't jump in here to defend Bill Clinton actually signing this failure of a repeal into reality. :bluewink:
But.. but... but.. it was approved by a Republican controlled congress! It's all THEIR fault!
The dogma lives loudly within me.
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QuirtEvans
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1hp
Jan 19 2009, 11:46 AM
I notice Quirt didn't jump in here to defend Bill Clinton actually signing this failure of a repeal into reality. :bluewink:
It was a long, sad process ... I was deeply involved in Glass-Steagall, both in private practice and then in government. The efforts to repeal Glass-Steagall started, way, way, waaay before Clinton ... we were fighting the good fight during the Reagan years ... and it is absolutely not to Clinton's credit that he let the process continue to its inglorious end.

If you'd like some honest historical perspective on where it all started and where the first holes in the dike occurred, I'd be happy to oblige you. But somehow I doubt that's what you want.
It would be unwise to underestimate what large groups of ill-informed people acting together can achieve. -- John D'Oh, January 14, 2010.
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Red Rice
HOLY CARP!!!
QuirtEvans
Jan 19 2009, 01:09 PM
If you'd like some honest historical perspective on where it all started and where the first holes in the dike occurred, I'd be happy to oblige you.
Hey Quirt, I'd like to hear about it.
Civilisation, I vaguely realized then - and subsequent observation has confirmed the view - could not progress that way. It must have a greater guiding principle to survive. To treat it as a carcase off which each man tears as much as he can for himself, is to stand convicted a brute, fit for nothing better than a jungle existence, which is a death-struggle, leading nowhither. I did not believe that was the human destiny, for Man individually was sane and reasonable, only collectively a fool.

I hope the gunner of that Hun two-seater shot him clean, bullet to heart, and that his plane, on fire, fell like a meteor through the sky he loved. Since he had to end, I hope he ended so. But, oh, the waste! The loss!

- Cecil Lewis
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1hp
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Fulla-Carp
Actually Quirt I'd be interested to hear your views. Only just started reading about this. 20 years of trying to repeal it says it started pre-Reagan, no? The Clinton jab was tongue in cheek as it looks like bipartisan groups voted overwhelmingly to repeal it, so Clinton had no veto on this anyway.
There are 10 kinds of people in this world, those that understand binary and................
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QuirtEvans
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Red Rice
Jan 19 2009, 01:10 PM
QuirtEvans
Jan 19 2009, 01:09 PM
If you'd like some honest historical perspective on where it all started and where the first holes in the dike occurred, I'd be happy to oblige you.
Hey Quirt, I'd like to hear about it.
I'll give you the nutshell version. There's a lot of detail that can be filled in around all of this, but this is the guts of what happened.

Banking in America was a very provincial business for a very long time. Banks took deposits, and made loans. And they did it state-by-state. There were laws that prevented banks from operating across state lines, and those laws were defended tooth and nail by smaller banks, who didn't want the big banks from New York, Chicago, and California coming into their home towns and competing.

There were also many laws (and regulations) that rather severely limited what banks could do. They were restricted to the business of banking, and only banking.

Securities firms, likewise, were barred from taking deposits. You had to be a bank to take deposits. (Don't get me started on cash balances in brokerage accounts, OK?) And they couldn't own banks, and banks couldn't own securities firms.

All of this traces back to the Great Depression. The laws separating banks and securities firms were all passed in the 1930s. At that time, it was thought that the way to keep banks from collapsing was to keep them out of risky activities. Stick to their bread and butter, and they'd be OK. Let the securities firms go nuts, if they wanted to, but set up a firewall between banking and securities, to keep the banks safe and to prevent catastrophic bank failures.

This worked quite well for a few decades, but it wasn't destined to last, because the separation of banking and securities was not a model that was followed in the rest of the world. In the rest of the world, banking and securities activities could be intermingled in the same company. As the world began to globalize, it was inevitable that both banks and securities firms would chafe at the restrictions that kept them out of each other's lines of business, because they were watching their foreign competitors do things that they were not allowed to do themselves.

So, one of the drivers behind Glass-Steagall reform was globalization. Banks argued that they had to be able to do what their foreign counterparts were doing. (And they were also arguing that interstate banking laws were preventing them from growing to a size they'd need to grow to to compete with giant foreign firms ... the Japanese banks were the most frequently cited example at the time).

The second was money market funds. Before the advent of money market funds (in the early 1970s, if I recall correctly), your average Joe would put his free cash in a bank deposit account, not in a securities firm. But, as money market funds began to be developed, securities firms were able to compete with banks for free cash of consumers. Banks no longer had an automatic stream of deposits that had nowhere else to go.

The third driving factor was loan securitization. Prior to the 1970s, if a company wanted a loan, they went to their local bank. The bank made the loan, then kept it on its books (or sold it to another bank). Big companies could borrow money in the debt markets, but that was expensive (compared to getting a bank loan), and the borrowers had to assume the credit risk of the company, which not everyone wanted to do.

With loan securitization, though, everyone could suddenly invest in debt instruments, without betting on the credit risk of an individual company. Instead, you'd effectively buy a slice of a lot of different loans. So, if one company went bust, you wouldn't lose all of your money. Suddenly, securities investors could invest in loans more cheaply and more easily.

During the same period, the mostly quiet mutual fund industry exploded with activity, as principles of diversification were sold to individual investors, and as index funds were developed that took out the risk of choosing a bad manager, because you were no longer taking the risk of a manager's investment decisions, you were just buying a piece of the market (Burton Malkiel's book, A Random Walk Down Wall Street, for example).

So, the banks saw themselves squeezed. They were squeezed by foreign competitors, who could do things they could not. They were squeezed by securities firms on the deposit side, because securities firms now had vehicles (money market funds) that could compete with bank deposits, and because it was suddenly more practical for individual investors to invest in securities through mutual funds and index funds. And they were squeezed on the lending side, because securities firms could compete with bank lending activities by re-packaging loans and selling them off to investors.

The most obvious solution would have been to change the laws that limited banks to banking activities. However, Congress wouldn't go along. Congress was solidly Democratic through most of that time (especially on the House side), the securities industry was a big contributor, and John Dingell (the legendary chairman of the House Energy and Commerce Committee), with jurisdiction over the securities industry, wanted no part of expanding bank powers. So the banks got nowhere in Congress.

Enter the Reagan Administration. The Reagan Administration was not beholden to the securities industry. The Reagan Administration was strongly in favor of de-regulation. And the Reagan Administration bought the banking industry's argument that they were being squeezed to death, and that they needed to be able to expand their activities.

In the absence of new legislation, the Reagan Administration appointed regulators who started re-interpreting the old legislation. Suddenly, things that banks had been prohibited from doing for generations were redefined as classic "banking" activities. (Some of the biggest fights were over bank efforts to engage in the mutual fund business.) And the walls started tumbling on interstate banking, too. One by one, states started letting out-of-state banks buy local banks. It started slowly, where two states would agree only to let banks in each state operate in the other state, too ... and then it moved on to regional compacts, where they were still trying to keep the New York and California banks out ... but, eventually, the laws against interstate banking crumbled.

So, it was a gradual process, and there were debacles along the way. Remember the S&L crisis of the mid-80's? That happened because the S&L regulators were persuaded that the S&L industry was threatened by its inability to compete when mortgage originators could make mortgage loans (the S&L industry's historic bread and butter) and securitize them, thereby taking away the S&L industry's most important source of business. The S&L regulators took the reins off, the industry went wild, and then everything collapsed like a house of cards. As Santayana said, those who do not remember history are condemned to repeat it. Welcome to the mortgage crisis of 2008.

Anyway, those were the roots of repeal of Glass-Steagall. It didn't happen all at once, it happened very gradually, over time, one activity at a time. The Comptroller of the Currency (who works for the Secretary of the Treasury, and is the regulator of national banks) had a lot to do with it ... during the Reagan years, he was on the bleeding edge of expanding bank powers through regulatory re-interpretation of the banking laws. The S&L regulators had a lot to do with it. Congress had a lot to do with it, because they didn't modernize the laws, and so the regulators tunnelled underneath them. The Fed, for its part, tried to hold the line, but it got dragged along, somewhat unwillingly, because once the Comptroller of the Currency authorized something for national banks, the bank holding companies regulated by the Fed had a fit if the Fed wouldn't let them do the same. And then the FDIC (the regulator of state banks) got dragged along, too, once the Comptroller and the Fed had acted. It became a race to the bottom.

It would be unwise to underestimate what large groups of ill-informed people acting together can achieve. -- John D'Oh, January 14, 2010.
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ivorythumper
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I think it fair to point out the S&L crisis was precipitated in large part by the change in capital gains laws (Tax Reform Act of 1986), which crashed the commercial development real estate market. Everything didn't collapse because the developers were given free rein, it collapsed because they were choked to death financially by the sudden change in tax laws that made their projects financially unfeasible, and their creditors took the hit. The fact that the S&L regulators had allowed banks to change their lending positions is one aspect of the problem, but that is not the cause of the collapse.

But otherwise, thanks for that explanation. You can go back to ignoring me.
The dogma lives loudly within me.
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Red Rice
HOLY CARP!!!
Thanks, Quirt. Excellent explanation.
Civilisation, I vaguely realized then - and subsequent observation has confirmed the view - could not progress that way. It must have a greater guiding principle to survive. To treat it as a carcase off which each man tears as much as he can for himself, is to stand convicted a brute, fit for nothing better than a jungle existence, which is a death-struggle, leading nowhither. I did not believe that was the human destiny, for Man individually was sane and reasonable, only collectively a fool.

I hope the gunner of that Hun two-seater shot him clean, bullet to heart, and that his plane, on fire, fell like a meteor through the sky he loved. Since he had to end, I hope he ended so. But, oh, the waste! The loss!

- Cecil Lewis
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1hp
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Fulla-Carp

I keep reading about the complaints that foreign banks could do things that US banks couldn't (no separation of banking and securities). So has this caused problems outside the US?

Is there talk about new regulation to stop all this from happening again in 20 - 30 years?
There are 10 kinds of people in this world, those that understand binary and................
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QuirtEvans
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1hp
Jan 19 2009, 04:32 PM
I keep reading about the complaints that foreign banks could do things that US banks couldn't (no separation of banking and securities). So has this caused problems outside the US?

Is there talk about new regulation to stop all this from happening again in 20 - 30 years?
It is, apparently, one of Obama's highest priorities.

However, it's unlikely that the re-regulation will look like Glass-Steagall. Too much water underneath that particular bridge. For example, if we went back to the 1950s or so, banks and bank holding companies couldn't own brokerages, at all. But B of A just bought Merrill, with the government's active approval, right? That's not going to be undone. In fact, except for Goldman Sachs, there really isn't any free-standing securities firm, any more ... at least not any super-large ones. (There are still smaller, regional ones, but not what we used to refer to as "bulge bracket" firms.)

Moreover, historically, there was a major separation of regulatory powers. The Comptroller and the FDIC regulated banks, the Fed regulated bank holding companies, and the SEC regulated securities firms. In recent years, the Fed has become more of a super-regulator for all sorts of financial entities (because they've allowed bank holding companies ... companies that own banks ... to engage in a raft of other non-banking activities). That's not likely to change, either.

It's more likely that the laws regarding what banks can do, within the bank itself, will be strengthened, and that the firewalls between the bank and other parts of a bank holding company will be strengthened. There's also likely to be laws restricting the sorts of risks that both banks and securities firms will be allowed to take ... because, as we've seen, those firms have gotten too big to fail, and therefore they cannot absorb the consequences of their own poor decisionmaking.
It would be unwise to underestimate what large groups of ill-informed people acting together can achieve. -- John D'Oh, January 14, 2010.
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big al
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Bull-Carp
Thanks for the history lesson.

I wonder if there are any new surprises lurking behind the weakening of the Public Utility Holding Company Act of 1935 (another depression-era law) in its 2005 revision?

Big Al
Location: Western PA

"jesu, der simcha fun der man's farlangen."
-bachophile
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QuirtEvans
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I Owe It All To John D'Oh
Do you know what the acronym for that law is, Al?

PUHCA.

Pronounced puke-uh.

I know very little about that law ... it's an arcane subspecialty.
It would be unwise to underestimate what large groups of ill-informed people acting together can achieve. -- John D'Oh, January 14, 2010.
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