The Demise of Glass-Steagall
On November 12, 1999 the President of the United States of America stood in
a press conference with Senators Gramm and Sabanes to celebrate the signing
of the Financial Modernization Bill. This new bill effectively kills the Banking
Act of 1933, otherwise known as Glass-Steagall. What does this mean for the
banking industry? How are consumers and investors affected by this new "old
style" legislation? In order to properly identify the significance of this
news, it is necessary to analyze the history of banking regulation and how the
government failed and succeeded in its objectives.
The President said during the press conference, "This will, first of
all, save consumers billions of dollars a year through enhanced competition.
It will also protect the rights of consumers. It will guarantee that our financial
system will continue to meet the needs of underserved communities…"
This is quite a sales pitch delivered by the President considering he is a Democrat
and would like nothing more than to save Franklin D. Roosevelt's Social Security
scheme, and yet he admits that deregulation, or to use his terminology, "modernization"
will benefit consumers. We are better off without the government completely
regulating the banking industry? If I didn't know better, I would have guessed
that it was a Republican president speaking at this press conference.
The Glass-Steagall Act was born of financial loss and panic in 1933. Senator
Carter Glass, a Virginia Democrat and Congressman Henry Steagall, an Alabama
Democrat, sponsored the legislation that bears their names. The legislation
prohibited banks from underwriting stocks or bonds. Additionally, the FDIC was
established. This insures bank deposits and expanded the Federal Reserve's power
to control the amount of credit its member banks can extend. In the four years
following the stock market crash on Wall Street in 1929, one-third of the nation's
banks collapsed. The false assumptions of banking negligence, particularly in
risky stock market investments, fueled the fire of regulation that would burn
for over sixty-years. The truth is that none of the accusations launched at
the banking industry have stuck. If any were true then, why would the change
occur now?
The Financial Times commented, "In principle, the agreement heralds a
US financial revolution, but it has been so long in coming that banks have already
found ways to do many of the deals that the proposed regulatory changes will
make legal." In 1970, Merrill Lynch carved out their share of the banking
industry by offering money-market accounts. Money-market accounts pay interest
and allow checks to be written off of the account. So, has Congress responded
in its usual fashion with too little too late? Since 1970, banks, securities
firms and insurance companies have been whittling away at the big stick that
was Glass-Steagall. The response in 1980 to money-market accounts offered by
securities firms was the Depository Institutions Deregulation and Monetary Control
Act. This Act allowed interest-bearing checking accounts. In 1983, the Federal
Reserve allowed BankAmerica to purchase Charles Schwab, a discount brokerage
firm. The sell is not permanent as Schwab, the founder, buys back the firm due
to federal restraints on BankAmerica. In 1990, J.P. Morgan, a bank, is allowed
to underwrite securities. The Riegle-Neal Interstate Banking and Branching Efficiency
Act in 1994 allows national banking, contrary to the McFadden Act of 1927. In
1998, a $70 billion merger between Travelers Group, an insurance company, and
Citicorp, a national bank, is announced. This merger puts pressure on Congress
to repeal Glass-Steagall since it is really an illegal deal.
Daniel Kadlec comments, "Individuals should end up getting faster answers
and better rates on things like home mortgages and insurance, and corporate
clients will be able to issue stock and buy directors' insurance with a single
call. One-stop shopping for financial services up and down the customer ladder
is mainly what this bill is about." Kadlec adds, "The new bill is
also about making financial-services firms in the U.S. big enough to compete
with universal banks in Europe and Japan. It is true that Americans enjoy simplicity
in banking. There are ATM's located on nearly every busy street corner in major
U.S. cities. This quick and easy attitude will be accompanied by better services
at more competitive costs.
The Financial Modernization Act does have its critics. Robert Kuttner recently
wrote in regards to the Modernization Act, "What all of these developments
have in common is the realization that more free competition often requires
the counterweight of more regulation…" he continues, "The more
the consumer threatens to become more sovereign, the more companies seek shelter
in mega-mergers…" and finally, "…in a market economy the
strong are able to take advantage of the weak." I disagree with the comments
made by Mr. Kuttner. I believe that legislation such as the Financial Modernization
Act frees up what Adam Smith described as "the invisible hand" that
directs the free market, whereas Mr. Kuttner prefers the "brass knuckles"
of regulation to keep the economy in line.
Other critics worry that, "…a rush of mergers might come too fast.
To qualify under pooling of interests - an accounting technique that allows
favourable treatment of future earnings but will soon be outlawed - a merger
has to be registered by the end of next year. That may push companies into acting
faster than they should." It is foolish to assume that mergers on the scale
of Travelers Group and Citicorp would occur only to maximize one year's accounting
profits. We must not forget that the consumer runs our economy, not the large
firms. These "mega-mergers" will create "a financial services
entity that offers a customer a dramatically simpler and more efficient experience."
According to J. William Gurley, there will be "[n]o more 9 to 5, no more
banking holidays. This is a no-nonsense, 24/7/365, 'consider it done' type of
operation. Can you say that about your current bank?"
Putting Glass-Steagall on the shelf is a huge step in the right direction. It is not often that the federal government will admit a mistake, and it is even more rare to see a reversal of a mistake, but this is the case with the signing of the Financial Modernization Act of 1999. There is no doubt consumers win this battle.