...I find this nostalgia for Glass-Steagall to be bizarre and disconnected from the realities of Financial Crises I and II. The theory behind Glass-Steagall (and GS-lite measures like the Volcker Rule and the swaps pushout provision of Dodd-Frank) is that banks with insured deposits are subject to moral hazard, and will take on too much risk. This problem can be reduced by restricting the activities in which banks with insured deposits can undertake. That is, the problem is deemed to be giving banks too much discretion on the asset side of the balance sheet, when the liability side is insured.
But this bears no relationship to what happened in the 2008 crisis, or the one currently going on.
For starters, most of the major institutions that cratered in 2008 were not universal banks that funded capital market activities (such as underwriting) with insured deposits. Indeed, the opposite was true. They were investment banks/broker dealers (Bear, Lehman, Merrill); GSEs (Fannie, Freddie); insurance companies (AIG); commercial or universal banks heavily dependent on wholesale funding; and SIVs (many of which did have connections to commercial banks, admittedly).
Indeed, one could make the case that those who prescribe Son of Glass-Steagall to cure our financial ilss have the diagnosis exactly backwards. Many of the institutions that cratered–notably the IBs and SIVs–did so precisely because they did not have sticky funding (like insured retail deposits): they relied on short-term, uninsured funding like repo and commercial paper. Others, like RBS, had some retail deposits, but notably were very dependent on wholesale (uninsured) funding, and that dependence had grown over time. All of these institutions suffered classic runs.
In this interpretation, it is the concentration of risk in institutions that do not fund primarily through insured deposits that is the problem. David Murphy has a new paper that looks at Lehman and RBS, and arrives at a similar conclusion. This would imply that Glass-Steagall is utterly off-point.
The history of banking in the US supports this view as well. Banking panics occurred throughout the 19th and first-third of the 20th centuries due to funding fragility. These panics destroyed banks that engaged in traditional banking activities like commercial and real estate lending. Yes, there were runs on investment houses too (Jay Cooke & Co., Barings) but the point is that it’s the liability side of the balance sheet that matters more than the asset side. There was tremendous diversity in the asset side of the balance sheets of firms that suffered runs prior to deposit insurance: there was very little diversity on the liability side. All were funded with short term liabilities that could run at the drop of a hat.
Similarly, S&Ls raped and pillaged deposit insurance even though they were very “narrow banking” institutions with significant restrictions on the asset side of the balance sheet (though those restrictions were eased by Garn-St. Germain in 1984).
As a last point, Financial Crisis II is concentrated in European banks heavily dependent on wholesale funding, and the underlying source of the problem is assets that regulators deemed to be utterly safe for commercial banks–highly rated sovereign debt. Relatedly, many of the assets that caused commercial and universal banks in the US problems in 2008 were again deemed by regulators to be super-safe, carrying very low (and in some cases zero) capital charges. The assets that are raising/raised questions about the solvency of financial institutions would have been perfectly copacetic even in a Glass-Steagall world...
streetwiseprofessor.com |
