Along with greed and stupidity, regulation has now entered the banking business lexicon, thanks to the credit crunch. Despite the fact that the lack of bank regulation over the last few years is actually their fault, politicians the world over have nevertheless become very fond of using it in the public domain. However when it comes to explaining exactly how such regulation should work there is precious little on offer other than dealing with ‘the bonus culture.’
A truly effective banking regulatory approach would have to apply in equal measure to the banks of all major countries, starting with the US. To this end the restoration of a now defunct US measure known as the Glass - Steagall act and its worldwide implementation could provide a structure to steer international banking back to stability.
The Glass - Steagall act (GSA) was introduced in 1933. Senator Carter Glass, formerly a US treasury secretary had established the Federal Reserve System. He largely drafted the act together with some amendments from Henry Steagall, a congressman and chairman of the House Banking and Currency Commission. The Wall Street crash of 1929 and the depression that followed had concentrated minds in the US government as to how banks should behave in the future. As a result the proposals of Glass and Steagall were generally well received. Broadly the principal feature of the act was to create two classes of bank; ‘Commercial’ and ‘Investment.’
Commercial banks were to be limited to generating no more than 10% of their revenues from securities trading (other than government bond issues). Off balance sheet deals were not permitted. From 1956 an amendment was added permitting the commercial banks to continue selling insurance products but not to underwrite them. Investment banks on the other hand were not to be so restricted in their activities.
All banks were given a year’s grace to declare themselves as being either commercial or investment after which time the act took the force of law. It was not perfect; being seen by many as overly restrictive and in 1999, under the Clinton administration it was finally repealed by the Gramm – Leach – Bliley act. This demolished the regulatory walls of Glass – Steagall, allowing all banks to engage in investments and underwriting or not as they saw fit. The rest of the world took note of this action by its largest economy and wasted no time in following suit.
In the light of today’s credit crunch crisis which has followed on directly from 1999, Carter Seagall’s view that there should be a clear distinction between boring but safe commercial banks and the rest is beginning to appear remarkably prescient. Probably a few of the original criticisms were justified but what is undeniable is that in the sixty six year life of Glass – Steagall the world’s banks in general and US banks in particular enjoyed an unprecedented era of prosperity and stability despite there being a five year long world war in the middle of it. Given the near collapse of many of our largest banks over the last twelve months, the outright repeal of it in 1999 now looks like a grave error: An error which can only be rectified by its reintroduction in some form at least.
1st February 2009.
Your Comments
Thanks for this article which got me googling glass steagall. Can anybody tell me why it was repealed in the first place?
Comment by stephan
The commercials had lobbied unsuccessfully for years for the repeal of glass - steagall. The straw that broke the camel's back was citibank who wanted to acquire travellers insurance, which of course was contrary to the act (it meant that they would then be underwriting insurance). Thus citigroup was born with the head honchos of the new organisation (now citigroup)not knowing a lot about the risks that insurance carries, especially when it came to covering shadow banking deals. So what the hell! The gramm - leach - bililey act was introduced which in effect declared open season for all the commercials. So the answer to your question stephan is as this article begins - 'greed and stupidity'.
Comment by Collin G.
Great article. Unfortunately greed and stupidity will kill anything like Glass - Steagall, even if politicians have the guts to bring it on. The banks have the government over a barrel.
Comment by John P.
The government could of course make a start by ordering banks that have drawn financial support from the taxpayer to separate their investment (AKA shadow banking) and commercial operations - or else! This would lay the ground for eventual disposal of the investment arms or vice versa once a market for either re-emerges. If something like Glass - Steagall does not stage a comeback, we could be facing yet another banking crisis in the years ahead; probably before we have finished paying for this one.
Comment by Figurewizard
Alistair Darling should read this article. Ordering RBS to scrap its bonuses, whatever the rights and wrongs of it all, is no substitute for fundamental reform. I know - I work for a bank and I know just how bad things are. A Glass Steagal MK2 could well be the answer in the long run.
Comment by GCG
I work for a bank too. I have just watched the Treasury Comittee grilling the heads of RBS and HBOS. Having heard these overpaid clowns' pitiful attempts to cover up their own inability to run a bank properly I say that lets bring glass steagall in. The sooner the better. The trouble is that Crosby, one of the biggest clowns of all is now deputy chairman of the FSA and a mate of Gordon Brown in the bargain, so whether it can happen soon is another matter.
Comment by diamondgeezer
Thanks for this article. I heard the ex chairman of RBS asked about glass steagall by John Thurso on the treasury select comittee and all we got from him was a load of waffle about it being an interesting question. Now I know why. Its because the banks are still as greedy as ever and are only taking taxpayer cash to tide them over until what they call the good old days return. If anything resembling glass steagall were brought into the equation, the top brass of our leading banks couldn't show huge profits out of fairy gold to justify paying themselves huge and undeserved bonuses again.
Comment by D. Belmondo
A good article and I agree with the findings. So apparently does Citigroup, who as Colin G points out managed to complete the demolition job on Glass - Steagall back in 1999. Their CEO Vikram Pandit is now considering hiving off the consumer (commercial) parts of the group and hanging on to the investment. Whether he can pull this off anytime soon is open to question but the irony is that of all people looking for a Glass Steagall approach to the future it is him. There's more at:
http://www.bloggingstocks.com/2009/01/13/will-citi-split-its-investment-and-commercial-banks/
Comment by Paul Benedict
What about the accountants who audited the books of the likes of Northern Rock, RBS and HBOS? Firms such as KPMG Ernst and Young and Deloittes are surely responsible for allowing these banks to run themselves into bankruptcy. Not only should glass steagall be restored as this article says but the auditors to the banks should be changed every three years with anything that could lead to a conflict of interest being disallowed. The law should also be changed to make sure that auditors should have to answer for any failure to sound the alert where problems are revealed. The auditor - bank relationship has been far too cosy.
Comment by diamondgeezer
You are absolutely correct about the role of the auditors. For example how was it possible for PWC to have passed the accounts of Northern Rock year on year with their business model exposing them to disaster in the event of even a minor shift in either interest rates or market sentiment (or both as it happened)? If they had only looked at the lessons of Overend Gurney; the last English bank to suffer a run in the 19th century they would have been aware of the dangers. Perhaps history should be added to accountancy as part of a would be auditor's curriculum.
Comment by Figurewizard
A conflict of interest is putting it mildly. The big accounting firms have been in bed with the leading banks for years while earning colossal fees from them. I have been engaged in auditing bank accounts myself and can tell you that when the audited accounts go up to the top floor for review and signature, what comes out is very different to what goes in.
Comment by anon
Glass Steagall bank regulation in some form or other is probably inevitable now but by itself it will not solve the problem of investmnent banking firms such as Bear Stearns and Merril Lynch. As Lord Turner of the FSA has pointed out, the danger of these collapsing and others like them threatened many banks' liquidity all across the world. This means that it is not just a Glass Steagall act MK2 that is needed but an internationally agreed new form of regulation for the likes of these, otherwise the risk of this happening again will remain.
Comment by honestbroker
Mervyn King said yesterday that a bank that is too big to fail is too big. He may be right but how would a lot more smaller banks help us avoid another banking crisis?
Comment by vicky
What we would get Vicky is more banks offering a wider variety of services. At the moment small business bank financing is ususally predicated on the value of the owner's home. That means that when a housing bubble bursts small business is squeezed. That in turn means fewer jobs and less competition; the exact opposite of what the economy needs.
Comment by Figurewizard
You are all looking in your own backyards for the cause of the credit problems when your backyards were not even built when this malaise started. Anon is closest but the rest of you are way out. "Perhaps history should be added to accountancy as part of a would be auditor's curriculum." You are so right Figurewizard and they should all be made to read monetary Professor Antal Fekete's masterpiece on banking honesty if they want to stop a repeat of what's happening now.
http://www.professorfekete.com/articles%5CAEFIsOurAccountingSystemFlawed.pdf
Also one insignificant little thing that no one ever notices and is the general cause of all western governments becoming monstrously sized creatures with immense appetites that eventually explode like Monty Python's Mr. Creosote is just one simple thing. No one in the western world legally owns their own body. In fact the opposite is true, everyone is collectively owned by all the various governments. This allows governments to assume responsibilities for such things as pensions, education and healthcare which always cost balloon-out simply because profit is not the motive. All become police states because everyone thinks they need more police protecting them. Luckily Mr. Creosote explodes and we can have another go at doing it properly next time.
http://www.primaryfundamentalright.org/index.php?pageName=pfrWhatIs
Comment by bernardpalmer
Bernard Palmer is right on the money! We're watching the slow collapse of the Euro because European governments, our own included borrowed by the billions to make up for the fact that they didn't have enough cash to pay for the goodies that would get us to vote for them again. Greedy self serving politicians make bankers look like philanthropists!
Comment by Ken Webb
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