A year ago, I wrote about a JP Morgan trader — the so-called London Whale — who lost $6 billion on a monster derivatives bet he made using unwitting depositors’ FDIC-insured money, an incident that for all its trespasses broke no actual laws (see “Billions Gone,” July 13, 2012).
So, it’s fitting that for my farewell column I’m writing about a bipartisan effort to dust off a defunct law that would have prevented what he did. More importantly, its reinstatement could erect a sturdy guardrail against the systemic banking crises that nearly brought our country to ruin in 2008.
That law is the Glass-Steagall Act, and leading the charge to bring it back, in partnership with Republican Senator John McCain, is Democratic Senator Elizabeth Warren.
Introduced in 1933, the Glass-Steagall Act separated the boring “retail” depository and lending operations of financial institutions from their investment banking wing. It was meant to safeguard against feverish speculating of the kind that triggered the 1929 crash and subsequent depression — which was only possible because bank traders had carte blanche to play deposit money on the stock market.
Glass-Steagall stipulated that if a bank wanted to make extravagant bets, it had to do so on its own dime. It served the country well until the 1980s, when it began to unravel in an era of headlong deregulation, and was finally repealed altogether in the 1990s. Its dismantling has been implicated by many in the 2008 subprime calamity.
Wall Street disagrees. Glass-Steagall wouldn’t have prevented the crash, they claim, because the trouble started with banks that were purely investment institutions: Bear Stearns and Lehman Brothers. Which is silly because modern banking hubs are so interconnected they operate as a single commercial and investment amalgam even if they’re nominally separate companies. In simple language, the new version of Glass-Steagall would untangle that complexity by restoring clear boundaries.
Banks also argue that the economy benefits when they’re allowed to make ordinary loans as well as trade securities and derivatives, the financial instruments used for speculation. Maybe so. But is the upside worth the danger? After all, the proof of Glass-Steagall’s efficacy is in the pudding. As Warren recently said, “From 1797 to 1933, the American banking system crashed about every 15 years. In 1933, we put good reforms in place, for which Glass-Steagall was the centerpiece, and from 1933 to the early 1980s . . .
we didn’t have any of that — none.”
Bottom line: all of this caviling is a blind. The real reason banks fear Glass-Steagall is that while it acts as a buffer against catastrophic losses, it holds profits in check too. Secondly, if banks are forced to spin off their investment divisions, they may lose their Too Big To Fail status, which would pose a direct threat to the safety net enabling their crazy risks. As long as they handle both federally-backed deposit money and speculating capital in a way that blurs the lines between them, they know they’ve got a stronger argument for taxpayer bailouts when their gambles go haywire.
With the memory of 2008 already wearing off, Glass-Steagall is more relevant than ever. Just five years after nearly self-destructing, big banks are booking record profits. All the arrogance of the 2000s is back, as witness recent revelations about Goldman-Sachs’ manipulation of the aluminum market and the mindboggling, industry-wide push to revive mortgage-backed securities. What’s more, Dodd-Frank, the battery of financial reforms introduced in 2010 to rein in runaway banks, has been hobbled by an army of lobbyists with a bottomless war chest.