The Not-So-Triumphant Return of Glass-Steagall

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The unlikely duo of John McCain and Elizabeth Warren want to bring back Glass-Steagall, the Depression-era law that split up commercial banking and investment banking. The basic idea behind this is sound: commercial banks are insured by taxpayer dollars, so they should be conservatively run. Investment banks, which make lots of risky bets, should be on their own.

But I’ve never been much of a fan of bringing back Glass-Steagall. There are several reasons, but I really only need one: in practice, its repeal doesn’t seem to have made any difference. Take a look at the two most serious bank failures in 2008: Bear Stearns and Lehman Brothers. They were both pure investment banks. IndyMac and Countrywide were pure commercial banks. Wachovia did both commercial and investment banking. AIG was an insurance company. Merrill Lynch was a pure investment bank that got rescued by combining it with Bank of America.

Now take a look at the strongest banks in 2008. JP Morgan Chase and Wells Fargo combined commercial and investment banking. Goldman Sachs and Morgan Stanley were pure investment banks.

Basically, I just don’t see a trend here. Both pure and combined banks failed in 2008, and both pure and combined banks succeeded. And that’s without even getting into the shadow banking system, where many of the problems of the financial crisis originated.

I’m in favor of smaller banks, and I suppose that splitting up the big universal banks would accomplish that. But either Congress is willing to split up the big banks or it isn’t. If it’s not, then the McCain-Warren bill won’t pass. If it is, there are far better ways of doing it.

For my money, I wouldn’t bother at this point. I’d simply mandate higher capital requirements for everyone, and much higher capital requirements for the biggest banks on a sliding scale. That would automatically put pressure on banks to stay smaller, and it would make them safer regardless of their size. It’s a better, simpler way to go.

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