The worst legislation ever

Reading The Unwinding (see yesterday’s post), one subject kept coming up: the world-wide financial crisis, the New Depression, the near collapse of the US economy in 2007-8.  It’s a good subject, an important one, one well worth studying.  After all, we’re five years down the pike, and our economy still hasn’t recovered from it, nor has Europe’s, nor has the World’s. So three–make that four–basic questions occur.  What caused it?  What can be done about it?  And, could it happen again?  And the fourth question, the real elephant in the room, why didn’t anyone go to jail?

And the first of those questions, turns out, is maybe the easiest to answer:  Gramm-Leach-Bliley.  Which repealed the Glass-Steagall Act.

This is exactly the kind of thing that Wikipedia is really good at.  Just two links, right there on the paragraph above this one, and look at what we learn.  Glass-Steagall was the Banking Act of 1933, named after its two co-sponsors, Senator Carter Glass of Virginia and Representative Henry Steagall of Alabama.  Two Southern Democrats, in other words.  And Carter Glass was a piece of work.  The 1902 Virginia Constitution, for example, instituted the state’s first poll tax.  When asked if it might not be, uh, discriminatory, Glass said ‘Discrimination!? That’s exactly what we propose!  To remove every Negro voter who can be gotten rid of legally!”  So by our standards, he was sort of a terrible human being.  But he and Steagall at least got a darn good banking law passed.

What Glass-Steagall did was make it illegal for commercial banks to get into bed with securities firms.  It separated banking from Wall Street.  Four main provisions of the bill, Sections 16, 20, 21 and 32, prohibited banks from buying or selling securities, being affiliated with companies that bought or sold securities, prevented companies from accepting deposits if they bought or sold securities and prohibited any officer with any  Federal Reserve member bank from working for a securities firm. Complete separation, in other words.  Bankers and stock brokers were like Angelina Jolie and Jennifer Anniston–couldn’t even trust ’em to be in the same room together.

But as the entire financial system of the US got more and more complicated, that line got harder and harder to maintain, or even to discern.  Lots of companies–investment banking firms, hedge funds–acted a lot like banks, and functioned a lot like banks, but didn’t count, legally, as banks. One possible response might have been to outlaw those kinds of companies; to keep the distinction alive between things called ‘banks’ and things called ‘investment firms.’  Glass-Steagall was passed in 1933, and the whole world of finance and investment had changed tremendously in that time.  It might have been possible to re-regulate, to strengthen Glass-Steagall, to keep banking and investing separate, to maintain the reality that Glass-Steagall had been a response to the biggest financial collapse in history, and there hadn’t been one since, so yay Glass-Steagall.  But to a lot of really smart, really rich people, financial regulations were antiquated and outdated and there was a lot of money to be made if we could just make them go away.  Hence, Gramm-Leach-Bliley.

The Financial Services Modernization Act.  Even the title gives it away–this was about modernizing!  This was about getting rid of old-fashioned, silly, arbitrary, unworkable old rules.  Gramm-Leach-Bliley erased distinctions between commercial banks, investment firms, insurance companies, securities firms.  What set it off was a merger.  In 1998, Citicorp, a bank, merged with Traveler’s, an insurance company, and scooped up Smith Barney while they were at it.

(Remember Smith Barney? Those great old ads, with John Houseman?  “Smith Barney: they make money the old-fashioned way–they earn it.”  In what looks like an exclusive men’s club, all stained glass windows and dark wood walls?  Yeah, turns out, not so much.  They made their money the new-fashioned way.  By CDOs (collateralized loan obligations), turning crappy sub-prime mortgages into structured asset-backed securities (ABS), in which the assets turned out to be worthless.  Which they could have figured out, with just a bit more hard work and research.  Just read this today; Morgan Stanley just bought Smith Barney, then dropped the name, which has become toxic.  Citigroup lost 3 billion on the deal.)

Okay, so Citicorp does this really illegal thing, a merger that directly and openly violates not just the spirit but the letter of Glass-Steagall.  One possible response might have been to haul Citicorp’s CEO and CFO and chief legal counsel away in handcuffs.  Instead, the Congress of the United States decided to get rid of Glass-Steagall, so the deal (and many many many other deals to follow) could go through.

Now, Phil Gramm is a Republican, and another piece of work. Although he was trained as an economist, his name is all over most of the worst ideas in American economic history.  For example, he was co-author of the Commodity Futures Modernization Act of 2000, the bill that specifically allowed Enron to run the biggest Ponzi scheme in history.  As for Gramm-Leach-Bliley–yeah, it was a Republican bill; much beloved by Speaker Newt Gingrich.  Jim Leach was a Republican.  Tom Bliley was a Republican.  But it would be wrong to label this a purely Republican piece of idiocy.  Robert Rubin, Bill Clinton’s Secretary of the Treasury, had just left office, but supported the bill.  Bill Clinton signed it into law. (Granted, he was pre-occupied with Monica fall-out at the time).   It’s true that John Dingell, Democrat from Michigan, said that it was a bad idea, that it would make banks too big to fail, and that it might lead to financial catastrophe, requiring a bank bailout by the US government.  But his views were dismissed as preposterous.  Alarmist fantasies, really.

Really, though, we should have known better.  John Dingell’s a House legend.  And we’d already seen what happens when you deregulate financial institutions–see, for example, the Savings and Loan crisis of the late 80s and early 90s.  Nearly a third of all American S&Ls went nuts, invested idiotically, went under.  (The Tax Reform Act of 1986 is the primary culprit in that whole mess.  Another Republican bill).

The world-wide financial crisis came when banks made hundreds and thousands of bad loans, because they knew investment houses would buy those loans, repackage them, securitize them, and sell them on bond markets. This wasn’t entirely predictable, but some similar kind of catastrophe was predictable. When very very large amounts of money are at stake, crooks will always, inevitably, show up.  Willie Sutton had it right–why rob banks?  Because that’s where the money is.

I have a sister-in-law who works for a bank, and she gets really angry when we talk about the role of banks in the financial crisis, because the bank she works for acted ethically, didn’t get into sub-prime, didn’t rip people off, and survived the crisis in good shape.  There were certainly ethical banks, lots of them.  In fact, a lot of the crisis came when small local banks–Washington Mutual, Long Beach Bank and Trust–figured out that they could become really big banks if they got heavily into sub-prime.  But other banks were properly cautious.  All true.  Still, the bad guys here were really really bad.

And they haven’t gone to jail.  And in part, it’s because of Gramm-Leach-Bliley–a lot of what they did wasn’t actually illegal.  But a lot of it was.  But prosecuting the CEO of Goldman-Sachs is really hard.  The Justice Department would soon find itself out-lawyered.  Putting the case together would take years.  And let’s face it, this was never a priority of the Obama administration.  And why would it be, when the President’s chief economic advisor was Larry Summers and his SecTreasury was Timothy Geitner?  These were Wall Street guys, Robert Rubin guys.  If you walk around on Times Square, and a guy picks your pocket for a five dollar bill, and you yell and the cops chase him down, he’ll go to jail.  But the CEOs of WaMu and Lehman Brothers will never do time.

I’m arguing that Gramm-Leach-Bliley may be the single worst piece of legislation in US history.  (Its only real competition is the Smoot-Hawley Tariff).  It’s rare, actually, to think of a law passed by Congress that had absolutely no upside at all.  It’s hard to imagine a bill that could accomplish nothing positive; that has entirely negative consequences.  But I sure can’t point to a single positive thing that Gramm-Leach-Bliley accomplished.  Tell me if I’m wrong; I think it’s a completely terrible bill. I think that repealing Glass-Steagall was the biggest mistake in our nation’s history, basically, ever.  (I should point out that it has its defenders, among them Bill Clinton, and more persuasively, economist Brad DeLong, who I really do respect, even when disagreeing.)  And I do admit that the Smoot-Hawley tariff was a rotten idea too, seeing as how it led to Hitler and all.

Could it happen again?  Oh, heck yes.  The bill that supposedly corrected the problems caused by Gramm-Leach-Bliley is the Dodd-Frank Act, the Wall Street Reform and Consumer Protection Act.  It’s a mess of a bill. Way too many loopholes, way too easy to sidestep and dodge.  It has one good provision, the creation of the Bureau of Consumer Financial Protection.  Which hasn’t yet been staffed or funded, due to Republican opposition.

The other night, The Daily Show did a nice bit about the Canadian banking system.  The Canadian banking system has not had a crash in the last 150 years.  Canada did fine during the financial crisis.  It did fine during the Great Depression.  There have been 16 banking crisis in US history–Canada has had zero.  Banks are much more regulated, of course, in Canada.  And respected.  And in the US, banks are really really not respected at all.  Which my sister-in-law, quite properly, finds infuriating.

I know I have libertarian and conservative friends who are opposed to regulating financial markets.  But the issue isn’t really that black and white.  Is regulation good?  No, regulation is bad!  Boo, regulation!  That’s a silly way to think of it.  Instead, let’s talk specifics.  Which specific regulations are we talking about?  What are they meant to accomplish and do they accomplish it?  I hear small businessmen complaining about the regulatory burden they face–I’m sympathetic.  What laws should we review?   But sometimes, specific laws of deregulation prove catastrophic.  When that happens, we should say so.  So we won’t be fooled again.




One thought on “The worst legislation ever

  1. juliathepoet

    Well thought out, and thought provoking. I did not understand just how different Canadian banking and banks were, until I saw how they work with their customers.

    I have a Canadian friend who I helped come up with a plan to pay off his debts. He had student debt, two cards and consumer credit loan, (with a variety of APR rates) all with differeng minimum payments. He asked for my help after getting a raise. He wanted to “spend” half of his additional income on getting a larger apartment, and the other half on paying off all of his loans, as quickly as possible.

    Since his student loans, consumer credit line and one of his credit cards were with the same Canadian bank, I suggested that he pay off the other credit cards first, since it had the highest APR, and could be paid off in 3 months if he put the entire amount towards it. I also suggested he talk to the bank that he had most of his loans with, to see if he had any prepayment penalties on his consumer credit loan.

    (Honestly, there was language I didn’t understand about the terms of his consumer credit and student loans, including credits for keeping his banking with the bank, but that fluctuated, and neither he or I really understood.)

    He decided to wait until after the holidays to look for a new apartment, and with extra holiday hours, he paid the most expensive credit card off in one month, November. He hasn’t had time to find out about the prepayment language, and so in December he made his usual minimum payments, and used some of his raise for Christmas presents, and kept the rest in his account until he had time to meet with the bank representative in mid-January.

    His meeting was a pleasant surprise. The language we didn’t understand essentially is an incentive to pay loans off early, in the form of decreased interest, calculated on the last three payments. In his case, he was able to pay his consumer loan off 6 months early, and so his last payment reflected a credit equivalent to the interest for those 6 months, deposited in his savings account. His student loans being paid off early ended up with a credit that was a little over 1 month’s paycheck deposited in his savings account.

    The short explanation about the refund was that the interest was calculated for the entire term of the loan, when it was issued so that the consumer sees the entire cost of the loan, before signing it. Instead of trying to make as much as possible, by charging hidden interests and fees, banks cared about the relationships with their customers. The banker my friend met with in January took the “best plan” we had come up with, and showed him how to actually pay it off two months earlier. She also suggested a savings account, specially made for saving for a future home down payment. It was much more generous than any savings account available then, or now, from American banking institutions.


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