Glass-Steagall wouldn’t have saved us from banking crisis
To the editor:
economist Paul Krugman’s assertions that many of our current financial woes were caused by the repeal of the Glass-Steagall Act. Passed as the Banking act of 1933, a major provision was the separation of commercial and investments banks. Commercial banks are those that provide checking, savings and lend money, your traditional home town institution.
Investment banks either help businesses raise capital by selling stocks or investors in buying of securities — your traditional Wall Street firm. I believed at the time and do now that the repeal of the Glass-Steagall act was a bad idea and that the reinstitution of something similar is warranted.
At the time of the repeal I would have been in a minority because this legislation had broad bipartisan support passing for example the Senate by a 90 to 5 margin when it went to conference. The rule would limit some risk by preventing certain financial institutions from becoming “too big to fail.” However it is simply partisan politics to suggest that the repeal of Glass-Steagall had anything but an auxiliary role in the 2008 financial crisis.
In particular Bear Stearns, Lehman Brothers and Merrill Lynch all failed wreaking havoc in the system but all are investment banks only having nothing to do with Glass-Steagall. American International is an insurance company and Fannie Mae and Freddie Mac have nothing to do with Glass-Steagall. Bank of America’s problems came from its acquisition of Countrywide Financial which made a lot of bad loans all permissible under Glass-Steagall. Citigroup is the only financial institution caught by the meltdown that would have been affected by Glass-Steagall by preventing trading losses and by keeping it from getting too big. But by the time the crisis hit Citigroup it was too late. What did cause the crisis? Lots of bad loans!
These loans were then used in financial instruments such as collateralized debt obligations which were overrated and immediately loss there value. There were two catalysts that resulted in so many bad loans. First the Community Reinvestment Act designed to encourage commercial banks to help meet the needs of borrowers whether qualified or not and low interest rates providing cheap money which in turn made the loans seem affordable. Putting partisan politics aside in this instance is extremely important. The Federal Reserve has spent hundreds of billions of dollars to fix the financial meltdown by propping up banks by making liquidity (cash) available, thinking we had a liquidity problem similar to the Great Depression. But what if it was different this time and the problem was a credit problem? Did we throw money away or worst yet let Wall Street bankers get richer addressing the wrong problem?
Solving a credit problem may be a long and difficult process. I would be interested in the professor’s response.