This prompts some obvious questions. What is the Glass-Steagall Act, why do the candidates Bernie Sanders and Martin O’Malley want to reinstate it, and how did it come to star in a presidential debate in 2015?
What is the Glass-Steagall Act?
When people talk about banking, they are talking about two broad classes of activities. Commercial banking is what happens at your neighborhood branch: You deposit money in a checking or savings account, and the bank uses those deposits to make loans to consumers or small businesses. Investment banking refers to the kind of banking activity more common on Wall Street, like helping large companies issue stock or bonds in order to fund themselves, and trading securities in hope of making a profit.
In the depths of the Great Depression, a widespread view was that the nation’s ills stemmed from these two types of banking having become intertwined. Problems on Wall Street rippled through the financial system to cause ordinary depositors to lose money and ordinary bank lending to dry up.
The government’s response was the Banking Act of 1933, commonly known as the Glass-Steagall Act (for the bill’s sponsors, Senator Carter Glass of Virginia and Representative Henry Steagall of Alabama), which required that commercial banking and securities activities be separated, not to take place within the same financial institution.
Why and how was it repealed?
Over the years, banks chafed at the limits on what businesses they could enter. The largest banks found themselves at a competitive disadvantage with banks from Europe that faced no such limitations and could offer both commercial and investment banking services to clients. Smaller banks in the United States wanted to begin offering investment management services.
Bankers and many regulators argued that the risks Glass-Steagall aimed to guard against were overstated (and indeed regulators began allowing activity that violated the spirit of the law well before it was formally repealed). In 1999, Congress passed and Bill Clinton signed the Gramm-Leach-Bliley Act, overturning Glass-Steagall.
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The action allowed the rise of several very large banks in the United States with business lines that cut across both commercial lending and securities business, particularly Citigroup, JPMorgan Chase and Bank of America. Those three banks alone have combined assets of about $6.5 trillion, or 36 percent of the United States’ gross domestic product.
So did that cause the financial crisis?
Not exactly! In a popular retelling (see for example this version from Aaron Sorkin’s HBO show “Newsroom”), it was the repeal of Glass-Steagall that unleashed the era of Wall Street risk-taking and the 2008 global financial crisis.
There’s no question that aggressive risk-taking by financial firms was a key driver of the crisis. But the arguments that Glass-Steagall’s repeal — that is, the commingling of investment banking and commercial banking within the same firm — was a major cause are tenuous.
Of the big firms that got into trouble and helped trigger the crisis, only a few were the mega-banks enabled by the action on Glass-Steagall.
Bear Stearns, Lehman Brothers, Merrill Lynch, Goldman Sachs and Morgan Stanley were all traditional investment banks heading into the crisis. Fannie Mae and Freddie Mac were government-sponsored housing finance companies. A.I.G. was an insurance company. Some of the banks that were most aggressive about making subprime and other risky mortgage loans included Washington Mutual and Countrywide, both of which were organized as a savings and loan in the run-up to the crisis. Wachovia was a big commercial bank that had also gotten into the insurance and securities businesses — but it collapsed not because of those activities but because of its top-of-the-market acquisition of mortgage lender Golden West.
It is true that two of the biggest bailout recipients were mega-banks with both commercial and investment banking arms, Citigroup and Bank of America. And while JPMorgan Chase and Wells Fargo weathered the crisis relatively well, they also accepted bailouts at the insistence of the Treasury and Federal Reserve in 2008.
In other words, the mega-banks that were enabled by Glass-Steagall repeal were certainly among the firms that caused the crisis, and did require bailouts. It is less clear that they were meaningfully more culpable than companies whose structure had nothing to do with the Glass-Steagall repeal, or that the existence of both commercial banking and investment banking under the same corporate entity was a primary reason they got into trouble.
The stronger arguments for Glass-Steagall repeal as a cause of the crisis are also subtler ones. The investment manager Barry Ritholtz, for example, has argued that “the repeal of Glass-Steagall may not have caused the crisis — but its repeal was a factor that made it much worse” by allowing the mid-2000s credit bubble to inflate larger than it otherwise would have and making banks more complex and thus prone to failure.
How does the Volcker Rule fit into this?
The Dodd-Frank financial reform law in 2010 included a rule that aimed to reduce risky activity in mega-banks — in other words, to address some of the same vulnerabilities that Glass-Steagall was designed to prevent without breaking up the banks completely.
The Volcker Rule, named for the former Fed chairman Paul Volcker, aims to prevent systemically important banks from engaging in casino-style trading activity. So, for example, Citigroup can still help a company issue bonds, but isn’t allowed to run an internal hedge fund in which traders place giant speculative bets on the direction of the Japanese yen.
Shaping those rules has been a hard-fought battle between financial reform advocates and the banks, and Hillary Clinton has proposed toughening it, including by eliminating a provision of the Dodd-Frank Act that allows banks to invest in risky hedge funds.
In other words, refinement of the Volcker Rule is a pathway for advocates of tougher limitations on banks’ risk-taking who do not want to break them up entirely.
So why is Glass-Steagall so central to the Democratic debate?
Glass-Steagall repeal is a useful cudgel for Bernie Sanders and Martin O’Malley to use against Hillary Clinton, not least because her husband signed the law that repealed it and because it is more instantly recognizable to many Democratic primary voters than, say, the tri-party repo market (a key part of the so-called shadow banking system that was one of the key transmission mechanisms for the 2008 crisis).
It allows them a point of differentiation with Mrs. Clinton, whose financial reform plan, released last week, includes big new fees on the biggest banks and new powers for regulators to break them up, but does not propose breaking up big banks outright.
In other words, the debate over Glass-Steagall reinstatement can be viewed as less about the gritty details of exactly what business lines Citigroup and JPMorgan should be allowed to engage in, and more about the general thrust of how aggressively to regulate Wall Street.
