Here Comes Glass-Steagall 2.0

The president proposed today a return to the spirit of Glass-Steagall, the 1933 legislation that barred the combination of investment banks and deposit-bearing commercial banks. Glass-Steagall was repealed by the Gramm-Leach-Bliley Act of 1999, allowing firms like Bank of America, JP Morgan Chase, and Wells Fargo to form as we know them today.

Citing the danger of having banks considered “too big to fail,” the president said Congress should move to split up the big banks that are engaged in both investment and commercial activities, and then have rules in place to keep them from merging again in the future. According to the LA Times:

“This prohibition says you can choose to engage in proprietary trading or you can choose to own a bank, but you can’t do both,” said a senior administration official, speaking on condition of anonymity before the White House publicly announced the plan.

Obama’s proposal builds on a provision in draft legislation by Sen. Dodd for reforming financial services regulation that would allow regulators to break up large institutions if they felt the firm had grown so large its collapse would bring damage to the market as a whole. Essentially the president’s idea is to keep commercial banks from owning a hedge fund or investing in private equity funds. They would still be able to loan money, in the form of mortgages and personal loans, but they would likely be banned from buying mortgage-backed securities or engaging in derivative trade.

Since the president likes a good show, he didn’t stop there with the plan. Obama also wants to limit the dollar amount of assets that any firm, commercial or otherwise, could hold on to. The details weren’t clear, but any ceiling would be a disastrous disincentive to entrepreneurial activity.

This proposal comes on the heal of a White House suggested bank tax. The critiques are similar: limiting the development of Wall Street through arbitrary caps and rules is not the path to recovery. Here are three reasons I gave last month for why a return to Glass-Steagall is a terrible idea:

First, the economic growth America experienced over the past decade was due in large part to repealling Glass-Steagall. While a lot of people have lost their homes, they and many more never would have gotten them in the first place without the increase in competition that came about through Gramm-Leach-Bliley.

Second, just because banks became over leveraged with weak lending standards and bad risk models, doesn’t mean they had too. While the repeal of Glass-Steagall contributed to creating an environment where the crisis happened, it wasn’t a foregone conclusion from the deregulation bill. Banks could have still acted more prudently with the advantages of Gramm-Leach-Bliley.

Third, European markets, which were much more intensively regulated and had Glass-Steagall-styled regulations were not protected from the crisis. It should not be simply assumed that a return to Glass-Steagall will be better for the economy.

I’ve written extensively on Glass-Steagall, see an archive here.


Nice to see the bump this annoucement gave to the stock market today…

The Dow Jones industrial average tumbled 210 points after dropping 122 on Wednesday. The index has seen four straight triple-digit moves and the latest slide erased the Dow’s gains for 2010. Bond prices rose as the stock market became more volatile.

Full AP story here.