Glass-Steagall Fans Are Not Fools

(Warning: Article about the business world ahead. Trust me, even if you don't care about business you just might find this interesting.)

In a recent interview with my former boss, Steve Forbes, Barclay’s Chief Executive Bob Diamond said something truly shocking. The subject was financial industry regulation, specifically The Glass-Steagall Act. Diamond contended that those who wish to see the return of this act simply don’t know what they’re talking about.

This is his exact quote: “The thing I find interesting is that people that I’ve heard say, ‘Let’s return to Glass-Steagall,’ when challenged actually don’t know what Glass-Steagall was. And, you know, Glass-Steagall may or may not have been appropriate in the 1930s. We certainly shouldn’t be looking backwards; we should be looking forward.”

Wow, that’s a lot to parse in just three sentences. And far be it from me to take issue with the thoughts of a leading banker, but that’s just what I am going to do.

First, let’s be clear. I don’t know who Diamond has spoken to, but it’s fair to say there are among those that want its return who are smart, informed and experienced hands in the financial world. Among those hands none are more experienced, or indeed more respected, than Paul Volcker, advisor to President Obama and former Federal Reserve Chairman. He is also one of the few who can honestly claim to have righted a broken economy.

Let there be no mistake Volcker is very much in favor of putting Glass-Steagall back in place. I base this on his statements before Committee On Banking And Financial Services of The House of Representatives, on September 24, 2009. Though he never mentions Glass-Steagall by name this is what he said:

“I particularly welcome the strong reaffirmation of one long-standing principal—the seperation of banking from commerce—that has long characterized the American approach toward financial regulation.”

Folks, that is Glass-Steagall. In fact this is specifically what Glass-Steagall was drafted to do back in 1934: keep banks and brokerages from colluding because our leading politicians then, unlike now, recognized that when these combined it lead to financial ruin. Glass-Steagall was then in place, with some revisions, until 1999 when it was replaced by The Financial Services Modernization Act, aka The Gramm-Leach-Bliley Act. Gramm-Leach-Bliley in turn gave bankers what they had craved all along: unfettered ability to mingle banks and brokerages and watch them grow, grow, grow. This, to our sorrow, is exactly what happened.

A little perspective is in order. When people think of the financial reforms of the New Deal, often the creation of the Federal Depositors Insurance Company is what comes to mind. In reality the FDIC was the last major piece of financial regulation created during FDR’s initial sweep of big reforms. The first thing he signed into law was Glass-Steagall. That’s how important it was. That it took over six decades for it to be overthrown, despite near constant lobbying from the financial services industry, is a testament to how reasonable, how good, how strong a piece of legislation it was.

It is this legislation, which helped rebuild America’s financial services industry from the ruins, Diamond mocks. It is people like Volcker, that he belittles.

Look, no banker wants Glass-Steagall back. Passing G-L-B was truly like handing the keys to the inmates. Banks went hogwild, soon becoming “too big to fail.” How could they not?

This isn’t conjecture, it’s fact. At the end of 1999, just after G-L-B was signed into law the financial services industry comprised just 13% of the total value of the Standard & Poor’s 500 index. By three years ago, during the bubble, that total had risen to 20.1%.

Of course what goes up must come down and that total had shrank to 8.8% by March 9, 2009 after the banks imploded. Now flush with taxpayer money the banks are back up to 16.3%. The lesson: banks win.

When G-L-B was signed into law Senator Phil Gramm (R-Texas) crowed about his new legislation. His press release from November 4, 1999 reads today like the worst case of unintended irony ever:

“I believe we have passed what will prove to be the most important banking bill in 60 years.” Yup, just not in the way he intended.

Then he castigates the banking regime he just helped overthrow, calling it largely inefficient and, if you can believe it, “unstable.” That sound you just heard was you smacking your forehead in disbelief.

As for G-L-B he insisted the future looked bright. It will “open up new competition,”—it did the opposite, making mega-banking conglomerates. It will “create wholly new financial services organizations in America”—it did, much to our woe. It will “literally bring to every city and town I America the financial services supermarket”—and it did, until they all collapsed and we ended up owning most of them.

By Gramm’s own criterion Gramm-Leach-Bliley has to be considered a fiasco. This is from his closing floor statements from the day GLB was signed into law:

“How will people judge whether we were successful in passing this bill today? … My test is, What are we trying to do in the bill? Are we trying to benefit banks or insurance companies or securities companies, or are we trying to benefit consumers and workers? … Ultimately the final judge of this bill is history.”

It is and history has spoken … to the tune of $800 billion in bailouts and counting, funded by consumers and workers, benefiting banks. On second thought maybe I am being too kind to Gramm. It’s entirely likely his questions above were rhetorical … we just didn’t know it.

A small footnote: after his illustrious senate career ended in 2002 Gramm immediately got a job with, yes, a bank: UBS. This is not too surprising because from 1997 through 2002 banks were by far his biggest contributors. A press release from the day he was hired said he would advise clients on corporate finance issues and strategy.

One hopes his advised his clients on strategy better than his new employer did, because from the day Gramm was hired until now UBS has been an absolute disaster, with its share prices down 14%, while the plain old S&P 500 is up 45%. It too, got bailed out. Gramm’s midas touch continues, yet somehow we end up paying for it.