The case for reviving the Glass-Steagall Act has surprising support across the political spectrum. Here’s why we should listen
‘The core of the case for Glass-Steagall starts with a broader question: how should the financial sector be structured?’
Eighty-five years ago this weekend, on 16 June 1933, Franklin Delano Roosevelt signed the Banking Act of 1933, better known today as the Glass-Steagall Act. Until it was formally repealed in 1999, the Glass-Steagall Act required a separation between depository banking and investment banking (and later, insurance companies).
In recent years, the idea of resurrecting the law has had surprising support across the political spectrum. Progressive Democrats have advocated for its reinstatement consistently since the financial crash of 2008. The official 2016 Republican party platform embraces bringing back Glass-Steagall. Former heads of Citigroup have said it was a mistake to repeal the law. And, for a time at least, the Trump administration seemed open to the idea of revival.
With such strange bedfellows in favor and federal regulators proposing to water down the Volcker Rule, which had some similar aims, it might seem surprising that there isn’t more energy to pass a new, modernized Glass-Steagall. What seems to be holding back its return is that many of the law’s skeptics fundamentally misunderstand the case for the Depression-era law.
We can think of a modern Glass-Steagall as something like a ban on mergers that create conglomerates
Critics of Glass-Steagall argue that the repeal of the law in 1999 didn’t really matter because it was watered down well before the 1990s. This is true, but hardly a sufficient criticism. Proponents of a modernized bill know that regulators started undermining the regime starting in the 1980s, which is one reason for a “modernized” bill. Advocates don’t seek just to undo the 1999 repeal, they want to both undo the earlier regulations that watered down the regime and to design a new regime that will be more likely to withstand erosion.
Second and perhaps most prominently, opponents argue that the repeal of Glass-Steagall didn’t cause the financial crash of 2008. There is truth here too. The end of Glass-Steagall wasn’t the proximate cause of the 2008 crash. But it was a contributing factor. The watering down and ultimate repeal helped further 30-year trends in the financialization of the economy and the consolidation of the financial sector into a smaller and smaller number of dominant firms – factors that indirectly precipitated the crisis.
Still, nothing important turns on this criticism because it is based on a cardinal mistake about public policy. People who focus only on the causes of the 2008 crash when thinking about financial regulation seem to think that the sole purpose of financial reform is to plug holes in a regulatory system in the narrowest possible way. But this is the equivalent of military strategists after the first world war building the Maginot line to prepare for trench warfare. It’s myopic to focus on the last war.
The core of the case for Glass-Steagall starts with asking a broader and more farsighted question of public policy: how should the financial sector be structured?
The case for reviving Glass-Steagall is based on two different premises. The first is a general opposition to concentrated economic and political power that is normally associated with anti-monopoly thinking. In recent months, economists and policymakers across the ideological spectrum have grown more and more convinced that concentrated markets across a variety of sectors are damaging the country’s economic wellbeing. As applied to the financial sector, these fears were ahead of their time. The 2008 crash focused attention on the ballooning size of the big banks, and solutions, like Glass-Steagall and capping the size of banks, were widely debated.
Indeed, we can think of a modern Glass-Steagall as something like a ban on mergers that create conglomerates. The purpose is to fragment power. When firms are smaller and separated by function, it is more likely there will be competition along specific business lines. Take a financial startup that wants to enter the depository sector. It will be harder for that startup to compete with conglomerates that can cross-subsidize business lines.
Concentration isn’t just bad for competition, it’s also bad for the political system. Too much economic power spills over into politics, giving massive firms an advantage in lobbying Congress or influencing regulators. In other words, concentration makes it more likely that government gets captured by corporate behemoths and that regulations are written to stack the deck in their favor. As Theodore Roosevelt noted a century ago: “There can be no real political democracy unless there is something approach an economic democracy.”
The Depression-era law regulated the US banking industry by splitting up depository and investment banking.
The second premise is that we should break up big financial institutions by separating their functions, rather than by capping their size (though it is not necessarily inconsistent to support both – and some proponents of Glass-Steagall do). There are many reasons to desire a financial sector that is fractured by function. Separation means government guarantees won’t cross-subsidize risky business lines. It can help reduce the risk of contagion – of a business infected with bad bets taking down the entire financial system. It will also make firms smaller (though it would still be possible to become large within a single business line). Together these factors make the financial system less susceptible to systemic risk.
Separation along functional lines also has a variety of legal and political benefits. It will improve the ability of regulators to monitor and regulate financial entities, indirectly making simpler regulations more viable. It also breaks up political power based on different kinds of financial activities, meaning that lobbyists for different parts of the financial system are more likely to find themselves on opposing sides of policy questions. That should, in turn, enable policymakers to design smarter and fairer regulations.
Financial institutions themselves might also benefit from such separation. Separation along functional lines makes compliance easier for banks that have become “too big to manage”. With fewer divisions and complex structures, management will have an easier time preventing the next London Whale. Indeed, employee culture within these institutions would likely change over time. Depository bankers, for example, could redevelop a culture of being “boring”, while investment bankers would remain risk-takers.
Of course, there are drawbacks to reviving a Glass-Steagall-like regime. For example, monopoly-sized firms and massive conglomerates are more likely to offer one-stop shopping and can more seamlessly integrate financial practices for customers. But any effort at making public policy has tradeoffs. The question for critics of a modernized Glass-Steagall is why they think these tradeoffs significantly outweigh the benefits of a financial system that is less concentrated, more competitive, easier to regulate, and that has less political power. If they want to make the case against Glass-Steagall, they must confront this question head on.