Five years after the housing and financial meltdown, self-styled progressives are still peddling their pseudoexplanation: that it was largely the fault of the 1999 repeal of a provision of the New Deal–era Glass-Steagall Act, which mandated the separation of commercial and investment banking. This tale is favored by Sen. Elizabeth Warren and others of her ilk, who hold the rather absurd view that the United States had free banking between the 1980s and the passage of Dodd-Frank in 2010. (See this video in which Warren attributes the growth of the American middle class to Glass-Steagall and the middle class’s decline to the repeal.)
One wonders if Warren et al. ever bother to look at the facts, particularly the passage of Glass-Steagall and what, if any, role the repeal actually played in the crisis. Since they never say anything specific, it’s hard to know if this is anything more than an incantation designed to blame the “free [sic] market” and to bolster their case for bureaucratic management of our lives (which they call “the economy”). It takes Herculean ignorance or dishonesty to claim that America had free banking before 2010. Hence, this is a classic confirmation of my observation that no matter how much the government controls the economic system, any problem will be blamed on whatever small zone of freedom remains.
According to folklore, Glass-Steagall was passed because of rampant conflict of interest and abuse among banks that both served savers and borrowers (commercial banking) and underwrote and sold securities (investment banking). But this is a case of the victors writing the history.
In “The Rise and Fall of Glass-Steagall” (2010), economists Jeffrey Rogers Hummel and Warren Gibson explain that Sen. Carter Glass realized his long-held goal of separating these two banking functions only after the 1933–34 so-called Pecora hearings in the U.S. Senate. (Ferdinand Pecora was chief counsel of the Senate Banking and Currency Committee.) “Revelations of supposed abuses by National City Bank (NCB) of New York and its president, disclosed in the Pecora hearings, provided the spark to ignite the issue and give Glass his victory,” Hummel and Gibson write. But the revelations revealed nothing terribly substantial against NCB or its subsidiary, National City Company (NCC).
Among the more serious charges, executives allegedly profited from the firm’s own securities underwritings. For example, National City bought a large block of stock in the new Boeing Corporation. Rather than sell this stock to the public, Pecora charged that NCC “retained a large block for itself and allotted the remainder to Mr. Mitchell and a select list of officers, directors, key men, and special friends.” But an internal NCC memorandum concerning this stock says, “[O]n account of the fact this industry is still somewhat unseasoned, even though we regard this particular company as sound and having a very bright future, we were not quite ready to make a general offering to our customers. It would have been next to impossible to avoid taking orders from the type of investor who should not buy this stock. Therefore, our own family and certain officers and employees of the Boeing Co. and affiliations have taken the entire issue.”
On which Hummel and Gibson comment, “Not only does this not sound improper, but in fact it sounds like just the sort of prudent regard for customers’ best interests that was supposed to be lacking in combined firms such as NCB/NCC.” It certainly was not a case of a bank peddling dubious securities to gullible customers.
However, they continue,
The committee produced a Mr. Brown, a witness who claimed to have lost $100,000 as a result of an NCC salesman’s bad advice. Bankrupt and in ill health, Mr. Brown was an ideally sympathetic witness, but it turned out that he had been a successful businessman and not a novice. NCB was forbidden to call rebuttal witnesses.
Economist George Bentson looked into the complaints against NCB and Chase Bank in his The Separation of Investment and Commercial Banking (1990) and concluded that they had no sound basis. Bentson “added a thorough critique of the supposed theoretical problems of universal banks such as conflicts of interest,” Hummel and Gibson write, continuing,
But what about conflict of interest? It is certainly possible that a banker in a combined firm might steer customers into ill-suited investments or insurance products. This is a hazard we face whenever we deal with professionals, such as physicians who advise treatments and also provide them, or lawyers who advise lawsuits and offer to file them. Such hazards are manageable: We can always get a second opinion or consult a fee-based financial planner or simply rely on the professional’s incentive to maintain a reputation for ethical service.
A few anecdotes and the potential for a conflict of interest were hardly good reasons for the government to arbitrarily separate financial functions, depriving customers of the benefits of integrated services. Hummel and Gibson write,
Financial institutions have widened their offerings considerably in recent years without any apparent problems. At the website of Wells Fargo Bank, for example, one finds not only traditional deposit and savings accounts and loans of all sorts, but also stock brokerage, mutual funds, automobile insurance, homeowner’s insurance, and even pet insurance. (But the Wells Fargo branch in a nearby Safeway store didn’t catch on and was closed.) Similarly, Charles Schwab, which began as a discount broker, now offers a full range of investment products and advice as well as banking services through its affiliated bank. Customers enjoy expanded services and lower prices as a result of the widening of competition among traditionally distinct firms. There is no sign of significant or widespread problems arising from conflicts of interest in such firms.
Hummel and Gibson add that success is not guaranteed for such companies, and they discuss some notable failed attempts by large firms to offer assorted financial services.
While the relevant part of Glass-Steagall was repealed in 1999, Hummel and Gibson point out that it was “becoming a dead letter” well before then. The repeal mostly codified reality.
“Incidentally,” they write, “no other developed country has ever seen fit to separate commercial banking from investment banking. Banks in Germany and Switzerland have always been free to engage in underwriting and securities holding to no obvious harm.” Aren’t we often told that Europe is much more enlightened in such matters?