Ever since the
full repeal of the Glass-Steagall act, there have been calls from some quarters
that it should be reinstated. Naturally,
this has sparked a number of responses from individuals and groups that were
the ones to gain from the act’s repeal insisting that All Is Well. This is made all the easier by the fact that
those demanding its reinstatement have no more idea of Glass-Steagall’s purpose
than those who were instrumental in its repeal.
Carter Glass |
Don’t get us
wrong. Glass-Steagall and similar laws
are essential to the functioning of a just free market system. The problem is that neither opponents nor
advocates know what it did.
Advocates, for
example, focus on risk, size, and what they believe to be an inherently corrupt
financial system that needs to be under more strict government control. One of the better critiques — that of Richard
Escow in the November 16, 2015 Wall
Street Journal — gave the following list of reasons (copied verbatim) why
the U.S. needs Glass-Steagall:
1. Too-big-to-fail banks
are bigger, riskier, and more ungovernable than ever.
2. The argument that
Glass-Steagall didn’t cause the 2008 financial crisis is wrong.
3. Repeal of the Act has
not worked as promised.
4. The repeal of
Glass-Steagall is further corrupting the culture of banking – if such a thing
is possible.
5. Too-big-to-fail banks
are a threat to our democracy.
Henry Bascom Steagall |
As we said, we
copied these word-for-word, and #2 is phrased badly: it should say “The
argument that repeal of
Glass-Steagall,” etc. Otherwise, it sounds as if Glass-Steagall
somehow caused the 2008 financial crisis.
Recently, William
M. Isaac and Richard M. Kovacevich gave us “The Shattered Arguments for a New
Glass-Steagall” in the April 26, 2017 Wall
Street Journal. Isaac’s and
Kovacevich’s argument was a bit more concise than that of Escow. It boiled down to one claim: that there is no
need to separate investment banking from commercial banking because investment
banking isn’t risky; the bigger the bank, the easier it is to diversify, and
that lessens risk.
We hate to tell
you (and whenever anybody says they hate to tell you, it means they’re loving
every minute of it), but neither side knows what they are talking about. Both sides in the discussion have been
missing the point of specialization and separation of function in a financial,
accounting, political, or any other kind of system.
An act like
Glass-Steagall is not intended to eliminate risk, but to institute and maintain
internal control in conformity with sound principles. This allows the system to operate properly
with built-in checks and balances.
Assessing the need for, or viability of, internal control measures
solely on the basis of risk is a straw man, as is mere size.
Any first year
accounting student is — or should be — aware that external control such as
government regulations, however detailed or comprehensive, is only effective as
a backup to good internal control. If
the system itself is not properly designed, no government fiat is going to make
it work.
What the repeal of
Glass-Steagall did was insert a great deal of uncertainty (not risk) as to the
legitimacy of certain practices. Under
Glass-Steagall, collusion between investment banking and commercial banking was
illegal per se. It was a matter of objective fact if it
happened, and could be prosecuted, whether or not any harm occurred.
It’s like getting
pulled over for speeding on a completely empty highway. You’re given a ticket not because you caused
any harm or endangered anyone, but because you broke the law.
After the repeal
of Glass-Steagall, collusion between investment banking and commercial banking
became “business as usual.” Yes,
financial institutions became bigger, greatly increasing the magnitude of
potential harm, but that is not the main point.
What the repeal of
Glass-Steagall did was transform something from objective fact to subjective
opinion. With collusion itself no longer
illegal, it became almost impossible to enforce controls of any kind on the
financial system.
Returning to the
example of getting pulled over for speeding, it’s as if all speed limits were
abolished. You could only be prosecuted
if you endangered or harmed others . . . which can be a matter of opinion to be
argued endlessly.
#30#