Financial Regulation

Don't Break the Banks

Why Obama's plan to reinstate Glass-Steagall is a terrible idea

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When Joseph Olear opened his renovated Three Point Bowling Center in south Orlando last May he didn't anticipate Wachovia taking an ax to his line of credit. Yet three months later the bank cut Olear's access to credit by almost 15 percent. "I opened up my statement and whack!" he says. "I thought, I should still have [more credit] to draw on. Nope." Did Wachovia slash Olear's credit because his business was failing? On the contrary, since opening his renovated facility, profits are up 25 percent. "In a down economy, an inexpensive sport like bowling becomes popular," Olear says. "Instead of groups doing Sea World or a golf outing, we're seeing them come here."

The reason Olear can't secure enough credit for his small business stems from issues far beyond the warmth and sun of central Florida. Credit is sparse nationwide, as banks hold their cash tight in a very uncertain economy.

That uncertainty stems largely from Washington's hostility to Wall Street. In the past few weeks, President Barack Obama has ratcheted up his rhetoric against the big banks, demanding they start lending more money to small businesses and fulfill their moral duty to help out average Americans, particularly in the wake of Wall Street's own financial bailout.

And the president has gone well beyond mere rhetoric, proposing a harsh new liabilities tax targeted at the top 50 or so financial firms (or any firm with assets over $50 billion) as well as new limits on how banks may be formed. That second proposal would effectively reinstate the wall of separation between commercial and investment banking that was first erected with the Glass-Steagall Act of 1933 and later repealed by the Financial Services Modernization Act of 1999. Together with threats of increased capital requirements from the White House and federal lawmakers designed to reform financial services, these proposals have banks of all sizes holding tight to their wallets.

In a normal economy, successful small businesses like Olear's (he says January is going to be a record month for profits) wouldn't face such a cold credit market. And Obama has certainly gone out of his way to show empathy for struggling small business owners. So it is ironic indeed that Obama now wants to handcuff or dismember the very banks that will offer this badly needed credit.

Here's the trouble with Obama's plan. First, separating commercial and investment banking is not the path to increased lending. Last week Rep. Judy Biggert (R-Ill.) explained to the Security Traders Association of Chicago why a return to the spirit of Glass-Steagall would cripple banks. "If firms are unable to buy and sell assets, where will liquidity come from in the future? How will auto loans and home mortgages be financed?" And the more banks that are handicapped, the less credit there will be flowing into the marketplace.

Nor did Wall Street respond well to the news that the big banks—a vital foundation upon which so much economic growth has been generated—might be broken up or have their business practices restricted. In the wake of Obama's attack, the Dow Jones lost 5 percent, erasing all gains since November 6, 2009. Similarly, the Nasdaq lost 5 percent and the S&P 500 lost 6 percent.

Was there lending in America before the repeal of Glass-Steagall? Sure. Much of America was built on the classic Savings & Loan model where deposits were lent out on a micro basis. But community banks simply don't have the capacity to meet the current demand for credit from corporations, small businesses, plants, and families. Breaking up the big banks would slam the brakes on the American economy.

Second, Obama's tax proposal will be a disaster for businesses and consumers. The U.S. Chamber of Commerce believes that expanding the tax burden will fundamentally undermine America's commitment to free enterprise. As J.P. Morgan Chase CEO Jamie Dimon has pointed out, "Using tax policy to punish people is a bad idea…. All businesses tend to pass their costs on to customers." This would be a double hit to the small businesses who've seen their credit decline thanks to the regulatory threats leveled at the big banks.

Even the diabolical political theorist Nicolo Machiavelli realized the risks inherent in using the "fear of taxes" as a punishment. Instead, Machiavelli advised good administrators to "provide rewards for those who desire to employ themselves."

Besides, even if the costs of the tax were not passed along to consumers, the tax would still fail to promote more lending. The problem with the credit shortage isn't that small banks can't compete in lending with the big ones. The problem is that the large financial institutions aren't readily shelling out cash like they did during the bubble years. This is partly because of a healthy reduction in excessively risky lending, but that reduction is also being exacerbated by the administration's perverse rhetoric.

Meanwhile, Obama inexplicably continues to pressure banks to lend more, while at the same berating them for lending too liberally.

Joseph Olear and other small business owners would love for banks to be able to relax their lending restrictions. But this won't happen until Washington ends its vindictive war on Wall Street.

Anthony Randazzo is director of economic research at Reason Foundation and author of the study "Rebuilding Wall Street: A Review of the White House Proposal for Reforming Financial Services Regulation."

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  1. “I want YOU to help me destroy this economy.”

  2. Dumbest. Fucker. Ever.

  3. And Obama has certainly gone out of his way to show empathy for struggling small business owners. So it is ironic indeed that Obama now wants to handcuff or dismember the very banks that will offer this badly needed credit.

    It’s not ironic – it’s just moronic. Obama is just showing his disdain for, and total lack of knowedge of, sound economic principles.

    1. Obama inexplicably continues to pressure banks to lend more, while at the same berating them for lending too liberally.

      No, it is pretty explicable: He is an incompetent socialist university professor who has a disdain for sound economic principles.

      1. He’s the black Paul Wellstone.

        1. No, that’s Sammy Davis.

  4. Yea, the govt should break up the sales it forced on the big banks earlier:

    Mugging Bank of America
    ..In other words, the feds believe that the way to calm financial markets is to force the nation’s largest, and a heretofore healthy, bank to swallow toxic assets it didn’t want. In return, yesterday the Treasury agreed to invest $20 billion in BofA, for which the government will receive preferred shares paying 8%. Treasury, the FDIC and the Fed will also partially insure $118 billion in troubled assets — mostly Merrill’s. In return for this downside protection, BofA will have to render unto Caesar another $4 billion of preferred stock plus warrants…

  5. Can’t trashing the economy wait for the recovery?

  6. This is a really bad article. The only argument in support of the supposed lede (why GS is a terrible idea) is a quote from a Republican congresscritter that such an action will apparantly further reduce lending — lending BTW, that was already severely curtailed long before any Obama threats. The rest is a screed on new banker taxes. While that may be a legitimate gripe, it has exactly zero to do with why GS is a “terrible idea.”

    Call me old-fashioned, but I happen to sort of like the idea of a bank as an actual lender and not a craps player.

    1. I’m pretty old-fashioned too. I like to hold a gun to people’s heads when they’re making economic transactions. Just reminds me of the good ol’ days.

      1. I am even more old fashioned and don’t think the banks should have special access to low interest money or guarantees from the US government. Cut them off from the Treasury and disband the FED

        Let them operate with their own money and if they make money they keep it, if they fail they lose.

    2. I agree about the quality of the article. For instance, consider the following quote:

      “Credit is sparse nationwide, as banks hold their cash tight in a very uncertain economy…That uncertainty stems largely from Washington’s hostility to Wall Street.”

      A claim that strong requires an empirical basis which the author neglected to provide. But this article isn’t about presenting a serious case on the economic merits, it’s about preaching to the choir. Which is fucking boring.

  7. Glass-Steagall had little if anything to do with the economy tanking, and reinstating it could help slow our economy even more.

    1. Exactly. Bear Stearns and Lehman Brothers would not have been effected by Glass-Steagall as they were both stand alone investment banks. In fact, the investment banks that weathered the storm the best were ones that were tied to commercial banks. It’s just convenient for the partisan hacks to point to Gramm-Leach-Bliley and say, “It’s the Republicans fault.”

      1. As noted by Johnny Longtorso above, Merrill Lynch was another stand alone investment bank that was about to go under before the government forced Bank of America to buy it. Chalk that up as another failure that would not have been prevented by Glass-Steagall.

        1. Please look up proprietary trading. Depository institutions participated in the trades with firms like Morgan Stanley and Lehman Brothers, who else sold them the mortgages to sell in the derivative markets. This is precisely the trades under Glass-Steagall that were prohibited. Investment banks and commercial banks collapsed because they did not have enough capital by gambling with their depositors money.

          1. Most MBSs are issued by Fannie and Freddie which are GSEs not commercial banks and would not be affected by Glass-Steagall. In fact, MBSs were issued as early as the 1970’s well before the repeal of Glass-Steagall in 1999.

          2. Selling mortgages to investment banks does not equal participation in derivative markets. Sorry.

  8. I can understand the many reasons for being against Glass-Steagall. But all of them seem to presume we live in an alternate universe where Congress can be trusted to not bail out failing banks.

    We don’t live in that universe, so if we have to have bad regulation to prevent occasional epic monstrosities of corporatism, then so be it.

    If you have a better idea for doing this (that would have a snowball’s chance in Hell of happening) then I’d like to hear it.

    1. Exactly! Similarly, in a world where we cannot credibly commit not to bail out large financial institutions, a tax on those institutions is a Good Thing insofar as the big banks see their gains from moral hazard taxed away.

      1. I’m inclined to agree with this. Consider the tax to be “bailout insurance premiums”.

  9. This is an idiotic. Taxes are lower than they have been in 80 years. Financial regulation has been more lax over the last 30 years (especially the last 10) since the great depression. Banks can make money from BANKING, like they used to. Back when people could get a decent retun on deposits, before interest rates were driven into the toilet, forcing everyone into 401K’s and other Wall Street enriching schemes. This libertarian crap is infantile. My son is a libertarian. He’s 8. I want what I want, NOW! How dare you regulate my TV and food!

    1. Do you have sources backing up your claims that “taxes are lower than they have been in 80 years” and that “financial regulation has been more lax over the last 30 years”? (More lax than what, by the way?)

    2. You lost me when you called me an “idiotic.” Does your 8 year old son call you that?

    3. If your son was a libertarian, he would be owing your lawn in exchange for his food, and washing the dishes in order to be allowed to watch TV. If he’s whining that he should be given something just because you have it and he doesn’t, then it sounds like you have a budding young liberal on your hands. You must be so proud….

  10. “slam the breaks” ?

  11. Taxes are lower than they have been in 80 years.

    citation needed.

    Financial regulation has been more lax over the last 30 years (especially the last 10) since the great depression.

    citation needed.

    Banks can make money from BANKING, like they used to.

    citation needed.

    My son is a libertarian. He’s 8.

    citation needed.

    1. RC, you remind me a lot of a Republican senator, just trying to gum up the works rather than debate.

      From now on, I demand that you provide citations for every sentence you write. Sound like fun?

      1. citation needed

  12. Banks and corporations who take the Feds money to save their sorry asses have no business complaining about being made scapegoats. Can anyone here say “welfare queens?” Take from the man, you pay the man and you dance to his tune, not yours.

    1. So you think it’s a good idea for the government to operate like the mafia? Make the situation difficult for the mark, come in and save the day, make them take on business they normally wouldn’t touch, and slowly worm your way into the entire operation?

  13. The Chamber of Commerce and the CEO of JP Morgan Chase are against this? Well, I’m convinced.

  14. Reinstating GS is a good idea. Our commercial (safe) banks should not be in the gambling biz. The rhetoric against it is BS. Banks would be fine, and lending would continue. God, how did we ever make it as long as we did when GS was crushing a lender’s abilities? I know Obama wants to destroy our economic system, so I have to scratch my head when I hear he is for this. Maybe enough positive pressure from the right places?

    1. Our commercial banks aren’t in the gambling biz. Your local bank is, at worst, selling it’s mortgages to investment banks to be repackaged as derivatives. That’s not gambling, that’s guaranteed profit, without the headache of having to wait 30 years for you to pay it back. For all the screeching about the evils of investment banks, I think your friendly neighborhood depository institution is quite happy to have them around. You should be too.

  15. Jesus keeps his money in la Banque de Montreal
    Jesus keeps his money in la Banque de Montreal
    Jesus keeps his money in la Banque de Montreal
    Jesus Saves
    Jesus Saves
    Jesus Saves…..

    But Gill scoooooooores on the rebound!

  16. The reason banks aren’t lending money is that the interest rate is too low. Obviously no bank is going to loan money to a business when they can make more (guaranteed) money buying government bonds. Obama should pressure the Fed to increase the prime rate*. GS, like all other regulations, is just a red herring.

    *Obviously it would be even better to eliminate the Fed and institute a free market banking system, but that’s never going to happen.

  17. Tony, I own a business and I have to tell you: you’re full of it. Every business owner I know puts the reinstatement of Glass-Steagall at the top of the reform list. Much stricter rules for the mortgage industry would be nice too.
    Wall Street has accumulated far too much power since 1980. Household income has gone practically nowhere since then. Growth in the non-financial economy has been modest at best since then, but the financial
    sector has increased nearly five fold. The job of the financial sector
    is to service the rest of the economy not the other way around.
    I’m not worried about credit. I
    want sales and profit. They have both shrunk considerably as a result
    of this near depression which was brought on by the culmination of thirty years of deregulation carried out through the incessant pressure of the banking lobby on Congress.
    Tony, you need to get out of DC and come to the real Washington. You know, Seattle, Vashon, Redmond. Being an apologist for oligarchs does not fly to well out here. Don’t forget to go to Portland. They use Atlas shrugged for TP there I’ve been told. By no means should you miss Vancouver BC. You know those Canadians. They’re socialists but they do have a budget surplus.
    Praying for the new Glass-Steagall,
    Owen

    1. Again, what “deregulation”? Statists always complain about deregulation but can never cite any examples.

      1. Funny how the most regulated industries (banking, finance, medical, insurance) are supposedly the ones most in need of “reform” and even heavier regulation?

        I wonder how that happens?

      2. GLBA
        CFMA
        2004 SEC leverage exemption

        Debate the merits all you want, but don’t be an asshole and act like barrels of ink haven’t been spilled discussing the above-referenced deregulation.

    2. You talkin to me? I was being sarcastic. I am for a reinstatement and many socialist policies besides.

  18. Two comments:

    1) Niccolo Machiavelli wasn’t a diabolical individual. He was a firm supporter of rule of law and the governing system of a republic. Read “Discourses on Livy” if you don’t believe me.

    He only wrote The Prince to try and get a job from a prince.

    I’m a devout libertarian who LOVES Machiavelli.

    2) It’s a GREAT thing that the banks aren’t lending. Their hoarding of the money from the bailouts is the only thing keeping back inflation and higher interest rates.

  19. Free markets do not exist. Market forces exist, and there are some aspects of society which should not be subject to them. The democratic process, for example.

  20. Look, at best, market forces are the ‘Id’ of a capitalist society. At some point the Ego has to reign in or control the Id to get beyond an infantile state. At some point you have to stop sh!tting your pants and learn to eat your vegtables. Libertarians prefer to ignore all societal dynamics other than a free market. Libertarian philosophy is simplistic, willfully ignorant, and infantile. Some have said that about Freud, but you catch my drift.

    1. How is it going MNG?

  21. Good lord, what an awful example of Washington D.C. “libertarianism” (i.e. shilling for big business).

    Banks stand against everything that non-Washington libertarians are for: free enterprise (not cartels), sound money (not inflation), sustainable growth (not bubbles).

  22. Rather a poorly written article if your old fashioned enough to believe body of piece should support the thesis…or be relevant to the thesis…or be relevant period.

    Glass Steagal would not have prevented the crisis, but that doesn’t mean it won’t reduce the risk of a too-big-to fail blowout in the future.

    Banks were selling their mortgages long before GS was repealed. Capital markets functioned just fine before GS was repealed. Banks did just fine before GS was repealed.

    Either you believe in omniscient regulators or you believe in too big to fail or you believe in limiting the size of institutions with systemic impact and FDIC insured deposits so that they can be shut down without risking a meltdown. Just because Obama is almost always wrong doesn’t mean he is wrong on this one.

  23. While I agree with almost every article posted on reason. I must disagree here. As long as we have the fed discount window and and federally insured deposits, having Glass-Steagall is definitely a good thing. Even if removing it wasn’t necessarily what caused the financial crisis, it is still a good idea.

  24. Oh well, late to the party, but i’d like to add my voice to the chorus. Reason mag has basically become, Big Business corporate interests = Libertarianism. It’s more obvious everyday.

    1. Reason is very consistently against government involvement in markets. If anything, that makes them anti-business by today’s standards (where the sole function of business seems to be asking the government for handouts). Of course less government intervention is sometimes good for corporations, but it’s always good for individuals.

      You also seem to be ignoring all the non-business related stories Reason publishes. Right now on H&R I see articles about government overspending, rampant nanny-statism, corrupt DAs, immigration, national security, and net neutrality. All of which have little to nothing to do with “Big Business corporate interests.” Your accusation is without merit.

      1. “but it’s always good for individuals.”

        Citation needed

        Are you really asserting that always under all circumstances, there would NEVER be a situation where more government intervention would be good for an indvidual?

  25. Not that it matters at this point, but the writers at Reason aren’t always the best, as will be true of any publication.

    Not trying to be specifically mean, but some are better at being objective and unbiased in their reporting than others.

    And we all have our bad days.

    Basically, agreeing with Chrispy here.

  26. You have money, give it to me.

  27. Wow this article really brought out the idiots.

    WH Owen, what the fuck should anyone care what a bunch of idiot small business owners and socialists fucks from the northwest think about economics and regulations.
    example: The job of the financial sector
    is to service the rest of the economy not the other way around.

    Wrong, the job of the financial sector is to make money or otherwise maximize the utility of their shareholders. They do this by investing and lending money, aka providing a service you need. If you don’t want the service or don’t like the terms, then find some other place to get your money.

    Some Guy:
    We don’t live in that universe, so if we have to have bad regulation to prevent occasional epic monstrosities of corporatism, then so be it.
    Two wrongs don’t make a right. By your logic congress should regulate what people eat, outlaw smoking, mandate excercise, etc, since they are subsidizing healthcare. You can’t regulate away risk or business cycles.

    Sether:
    Back when people could get a decent retun on deposits, before interest rates were driven into the toilet…
    This one statement shows that you know nothing about finance or economics. Interest rates are based on return for risk. Interest rates were high circa the 70’s because of high inflation, which was curbed. Everything else you said was too idiotic to respond to.

    Sean Scallon:
    Banks and corporations who take the Feds money to save their sorry asses have no business complaining about being made scapegoats.
    What about the banks that were forced to take the loans and the banks that already paid it back with interest?

    Beowulf:
    Capital markets functioned just fine before GS was repealed. Banks did just fine before GS was repealed.
    People survived in communist Russia, but that doesn’t mean it was a good idea. What is “just fine” exactly and why do you get to decide that?
    Either you believe in omniscient regulators or you believe in too big to fail or you believe in limiting the size of institutions with systemic impact and FDIC insured deposits so that they can be shut down without risking a meltdown.
    Nice false choice you’ve set up. See, maybe you could believe that there shouldn’t be regulation to hinder growth of a business (bank) so that when a big one does fail maybe there will be s couple medium sized businesses (banks) that can buy it out or just step in to provide the services needed. If you’re going to take risks you should be prepared to fail and no one should be required, including taxpayers, to bail you out. You can’t regulate away risk, and yes, even deposits have risk.

    Everyone else just apply previous answers as needed. Sorry, I don’t have time to give the full finance and economics lessons needed.

    1. “Mr. Simple” – did you pick that yourself, or was it something that all your friends and family came up with?

  28. “Meanwhile, Obama inexplicably continues to pressure banks to lend more, while at the same berating them for lending too liberally.

    Joseph Olear and other small business owners would love for banks to be able to relax their lending restrictions. But this won’t happen until Washington ends its vindictive war on Wall Street.”

    Tim Cavanaugh, are you reading this?

    This is a pretty good piece, but it doesn’t really get to the center of the issue, at least as far as the Obama Administration is concerned.

    The reason Obama talks about stripping big banks of their investment operations has nothing to do with anything else but curbing their bonuses…it’s hard for intelligent, thinking people to believe that’s the Obama Administration’s primary concern but it’s true.

    The Obama Administration doesn’t want any headline bonuses being paid by Wall Street on their watch. So there’s no contradiction as far as the Obama Administration is concerned if they’re telling Wall Street to keep taking risks and penalizing risk taking behavior…

    Keep lending but don’t pay big bonuses.

    The effect of Obama terrorizing Wall Street may be a stifled recovery, but the Obama Administration doesn’t care about the recovery–not if the recovery means that Wall Street is paying big bonuses. We can’t have big bonuses in the news! That may not be the Obama Administration’s only economic concern, but it is his primary concern–and everything else pales by comparison.

    …and the Administration’s shown it again, and again and again. Go look at every major announcement, whether he’s talking about stripping the banks of their investment arms or instituting his punitive “risk tax” (which he proposed after they’d all paid TARP back), and all the rhetoric is about obscene Wall Street bonsuses.

    http://www.youtube.com/watch?v=zMdwzvxpV5M

    Yeah, that’s a stupid way to run a country, but that’s never stopped anyone before.

    P.S. If you watch the video, keep a couple of things in mind…

    1) The Speech was made on January 14, by then almost all the banks had paid the Tarp money back–but it’s important to remember that most of the banks were not allowed to pay the money back before June of ’09.

    2) So, the TARP money he’s talking about them paying back isn’t about the TARP money they were given–he’s talking about covering the losses of those who haven’t paid their TARP money back.

    The TARP participants who haven’t paid their money back are AIG, General Motors, GMAC (General Motors’ finance arm) and Chrysler.

    Make of that what you will. Pretend it doesn’t mean what it does if you wish. But I’m not going to pretend he isn’t trying to make Wall Street pay for Detroit because that’s what it is–plain and simple. That’s a fact.

  29. The point on taxing the banks is reasonable, the point about glass segal, is bullshit,

    One of the primary drivers behind the current crises it WAY to much leverage. Especially by the big banks. We don’t need more exotic finacial instruments.

    If banks need to raise money, then can either 1, get more deposits, or two, sell bonds.

    Banking should be boring, and a small part of the economy.

    Higher capital requirments, and an end to most of the new financial instruments is what the world really needs.

    You say modern companies need all that credit, well isn’t that the problem, the system has gotten screwed up.

    You don’t think so, what if I said modern governments need that much credit or leverage. Debt fueld is the way to go…

    Now you see how stupid that is right?

    Of course there is a place for credit, and it’s somewhere down near historical levels. Where finacial compainies stopped trying to get 20-30% a year returns based on 30-50x leverage.

  30. the “outdated” savings & loan model did NOT crash this economy (keeting notwithstanding).

    degenerate gamblers on wall st, enabled by “bribed” feds & lax regulation & auditing, created CDS’s to mitigate sub-prime risks thus de-coupling lenders fm consequences.

    as greenspan noted he INCORRECTLY assumed wall st execs would have the “best interests” of shareholders at heart.

    restore glass-steagall & state bucket laws.

  31. I wouldn’t call Macchiavelli diabolical – rather, he was a pragmatist cynic

  32. The banks should be made smaller. TBTF is just TB. But breaking up groups into separate commercial and investment firms doesn’t make anything safer. Extra taxes won’t make up for the risk, as soon as they pay “insurance” for being TBTF they’ll just try to get their money’s worth out of the insurance. It will merely penalize the prudent by making them pay for the the reckless.

  33. whatever it is that you are inhaling..I would like some. are you being subsidized by “banks”..?

  34. This entire article is troubling. GS is not the issue and it is misleading, though perhaps not intentionally, to focus on it. That is just one possible means to a much needed end: real reform of how banks (commercial and investment varieties) operate. Anyone who believes that the status quo is acceptable is not thinking rationally. I am an American first and a partisan second. America is in the crapper and acting like it’s just going to disappear on its own is self-indulgent at best. At worst, it’s criminally insane. Obama, Congress, partisan politics, radio personalities and the like are not to blame. I have meet the enemy, and it is us.

  35. My only point is that if you take the Bible straight, as I’m sure many of Reasons readers do, you will see a lot of the Old Testament stuff as absolutely insane. Even some cursory knowledge of Hebrew and doing some mathematics and logic will tell you that you really won’t get the full deal by just doing regular skill english reading for those books. In other words, there’s more to the books of the Bible than most will ever grasp. I’m not concerned that Mr. Crumb will go to hell or anything crazy like that! It’s just that he, like many types of religionists, seems to take it literally, take it straight…the Bible’s books were not written by straight laced divinity students in 3 piece suits who white wash religious beliefs as if God made them with clothes on…the Bible’s books were written by people with very different mindsets…in order to really get the Books of the Bible, you have to cultivate such a mindset, it’s literally a labyrinth, that’s no joke.

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