Tuesday, October 15, 2013

Glass-Steagall: Time to bring it back

Recently, I was perusing the monthly issue of the Costco connection. In addition to articles on the newest goodies they sell, the magazine features a monthly discussion topic called “informed debate” - usually on a political issue, with “expert” commentary pro and con, along with comments by Costco customers. The recent issue dealt with whether the U. S. Banking Act of 1933, colloquially known as the Glass-Steagall Act, should be reinstated.

The purpose of that Act, written in the depths of the Great Depression, was to tame the boom/bust cycle to which the American economy had been increasingly subject in the decades following industrialization. It did so by, among other things, prohibiting commercial banks from owning securities brokerages – in other words, it erected a wall between commercial banking (like the kind you use for your checking or passbook savings accounts) and investment banking.

Let’s judge for ourselves the success of the Glass-Steagall Act by looking at some numbers:

A recession or depression is defined as two consecutive quarters in which America’s Gross Domestic Product (GDP) contracts. Contractions in GDP from 1901-1933 ranged from 10% to 32.7%. From the end of World War II to the end of the 20th century, GDP contractions ranged from .6% to 3.2% – an astonishing taming of some previously volatile numbers. Of course, GDP is but one indicator of an economic downturn’s severity. Another, more personal indicator, is unemployment rates. Unemployment levels were not tracked until the Great Depression, so accurate numbers are difficult to come by. But the unemployment rate at the time Franklin Roosevelt took office was at least 25%, and if underemployment is factored in, the combined rate was probably closer to 50%. (Not to mention the millions of Americans working for less money, with no benefits - and in the absence of job stability, afraid to spend the little money they had.) After World War II, unemployment was never higher than the 10.8% in November of 1982. (I have deliberately left out the “fake” February-October 1945 recession that was the result of post-war conversion to a peacetime economy – where GDP contracted by 12.7% but unemployment peaked at only 5.2%.) In short, the Glass-Steagall Act worked.

The most crucial provisions of the Glass-Steagall Act were repealed by the Gramm-Leach-Bliley Act of 1999, passed by the Republican House and Senate, and signed by President Bill Clinton. Even though the G-L-B act would have sustained a presidential veto, I won’t defend Clinton’s signing of the Act (nor will I defend his signing of the Defense of Marriage Act, which would have also sustained a veto – but that’s a subject for another post). The enactment of G-L-B was short sighted, based on the ludicrous assumption that the United States has entered an era in which recessions would be a thing of the past. Yes, there were actually people in the late-1990s who believed there would never be another recession, just as there were those in the early 1990s who referred to the “end of history” following the peaceful conclusion of the Cold War. History’s verdict on their commentary echoes Carl Sagan’s comment that “Intellectual brilliance is no guarantee against being dead wrong”.

Forgotten lessons are often painfully relearned: the March 2001-November 2001 recession, coupled with the September 11 attacks, reminded Americans that we weren’t indestructible. But that small GDP contraction of .3% was peanuts compared to the 4.3% contraction we suffered from December 2007-June 2009. There is a direct cause and effect relationship between the Glass-Steagall Act’s repeal, the slew of toxic investments, and 2007 subprime mortgage crisis - which led to the economic collapse of 2008. The repeal of Glass-Steagall allowed commercial banks to engage in risky investing, including mortgage-backed securities and collateralized debt obligations. This led to the subprime mortgage crisis which led to the collapse of the United States housing bubble. Falling housing-related assets contributed to the global financial crisis, even as oil and food prices soared. That crisis led to the failure or collapse of many of America’s largest financial institutions: Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers, Citi Bank and AIG, as well as a crisis in the automobile industry. Many of the aforementioned were deemed “too big to fail” and were bailed out by American taxpayers.

Reading the comments in the Costco Connection by those who came out against reinstatement, I’m compelled to wonder if these people were conscious during the events of 2007-2008. In particular, the idea that reinstating Glass-Steagall would imperil economic growth is absurd, and refuted by the fact that the United States has enjoyed several periods of robust economic growth while the Act was in full force, including the 1960s, the middle 1980s, and the explosive growth in the 1990s – the years immediately preceding the Act’s repeal.

It’s time to reinstate the Glass-Steagall Act.  If the present Congress won’t do so, it’s time to elect a new Congress.

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