Senator Warren’s Glass-Steagall Obsession

by Patrick Brennan

Josh Marshall of Talking Points Memo points to this video as another example of Elizabeth Warren Mass-splaining why her proposal for a “21st-century Glass-Steagall Act,” which would essentially separate deposit-holding commercial banks from investment banks, is such a great idea. “If you’re an Elizabeth Warren fan or really if you’re just into facts, you gotta watch this,” Marshall gushes. He says it looks like “the sort of matter-anti-matter reaction that happens when someone who actually knows some history and policy makes first contact with a gaggle of ignorant CNBC yakkers.” Viewers who know the history and policy Warren’s talking about probably will think otherwise.

The segment begins with a CNBC asking Warren a reasonable question: Wouldn’t reinstating the law be “hugely disruptive” and “really hurt credit creation” at a time when the economy needs it?

Warren dismisses this out of hand, saying, “that was pretty much what the banks were saying back in 1932 and 1933. . . . They raised all kinds of objections to it.” This, of course, isn’t really an argument — the fact that banks put forth such arguments in 1933, a vastly different situation than today, doesn’t really say anything about whether they’d be true now (or were true then).

Instead, Warren argues, we absolutely have to have Glass-Steagall, regardless of the costs that she won’t address, because it’s the silver bullet for banking crises. “We have 50 years following Glass-Steagall in which we had a tiny number of bank failures,” she explains.

This is pretty much true: There were few bank failures for decades after the Great Depression, when Glass-Steagall was passed (though it hardly ended the bank failures of the ’30s. See this graph, the year-by-year data is here.)

But the “facts” that apparently so impress Marshall are deeply muddled: Glass-Steagall wasn’t around for just 50 years — it was in effect all throughout the chaotic 1980s, weakened substantially in the ’90s, and repealed finally in 1999. Even accepting such an utterly simplistic argument, ignoring everything besides Glass-Steagall that affects our financial system’s stability, the law was in effect during the 1980s, the worst period of banking failures in U.S. history. As the anchors point out, the worst commercial-bank failure in U.S. history until 2008, Continental Illinois, failed before the repeal of Glass-Steagall, without any investment-banking activity at all.

Warren cites two major, famous crises of the 1980s and 1990s, both of which have vanishingly little to do with Glass-Steagall: the savings-and-loan crisis and the failure of Long-Term Capital Management. The savings-and-loan crisis had something to do with deregulation — but the deregulation of, you know, S&Ls, not commercial banks or investment banks. (There was also the end of high inflation, huge changes in the tax system that caused a mortgage and real-estate crash, etc.) And Glass-Steagall was still around — the S&Ls required a huge taxpayer-funded bailout because there were a lot of them and some were fairly big, not because of their connection to risky investment-banking bets or anything else.

Then she brings up Long-Term Capital Management, a hedge fund that had nothing to do with commercial banking and failed in the late ’90s because of bad management of the Russian and Asian financial crises. The Federal Reserve approved a bailout of sorts for the firm because it had attracted a lot of capital from such a diverse range of places on Wall Street and leveraged it so much that the firm posed a systemic risk. If Warren would like to propose a regulation that somehow prevents that, she should. It wouldn’t be Glass-Steagall.

What’s even odder is that Warren doesn’t just think Glass-Steagall and regulation can do things it can’t, but she actually thinks they can immanetize the eschaton. One of the anchors asks the senator whether it’s worth admitting that “there will be bank boom-and-bust cycles, no matter what the laws and regulations, you can’t protect everything.”

Warren’s response? “No, that is just wrong.”

Asserting that we can regulate credit crises and booms and busts out of existence is not necessarily the most ignorant or delusional thing a U.S. senator has ever said (I imagine there’s a lot of competition), but it should be up there. This is “somebody who knows some history and policy”?

A lot of people, including myself, would dispute Warren’s argument that the banking regulations passed in the 1930s and removed in the ’70s and ’80s explain the low number of banking failures and lack of credit crises in the intervening decades (which is not to say we couldn’t use new regulation or that regulation doesn’t help, a straw man she throws at the CNBC anchors). But even if she’s mostly right, that’s not an argument in favor of restoring Glass-Steagall out of all those regulations. It’s especially not a convincing point for Glass-Steagall by her own logic, since Glass-Steagall was repealed after the credit and banking crises of the 1970s, ’80s, and ’90s (which involved many more commercial-bank busts than the 2008 crisis).

She suggests that the law is a way to limit the size of banks, which, ceteris paribus, could well be useful — but it’s really not a good way to do it. As those feckless anchors point out, there are other ways to limit the size of banks, much more direct ones, such as raising capital requirements. What boring (equally simple) regulations like that don’t have, though, is Glass-Steagall’s intuitive appeal and, as Jim Pethokoukis smartly pointed out in his NRO column, its nostalgia. But that’s not what makes good regulation — it’s what liberals do to feel like they’re doing something to benefit the middle class, merely because banks don’t like it.

And that’s precisely the problem with Elizabeth Warren. Liberals like to put her forth as the ideal policy-based, rigorously informed politician, because they like her, and that’s what they’d like to think they like. And as seen in this interview, she certainly can fling some facts, but without any particular logical coherence, honesty, or context. She’s not a rigorous policy thinker or someone who deploys particularly incisive arguments. Rather, she picks appealing-sounding policies that seem to benefit the middle class at the expense of the wealthy and their investment banks, and then, as she likes to say, hammers away about them, without much serious attention to detail or consequences. Of course, this is kind of the job of a politician, but liberals like to pretend she is something else.

For more of Warren’s ostensibly impressive command of history and policy, here’s a central line from a joint statement with the other senators proposing the bill:

Under Glass-Steagall, major investment banks such as Drexel Burnham and Salomon Brothers failed without creating serious contagion in the broader economy. But in the post-Glass Steagall world of the 2008 crisis, the failure of investment banks like Bear Stearns and Lehman threatened the entire economy.

This argument makes even less sense and more of a hash of the facts than what Senator Warren said on CNBC. You might assume the point here is that the absence of Glass-Steagall had allowed Bear Stearns and Lehman Brothers to do something that made them more contagious, triggering the financial crisis, while Drexel Burnham and Salomon Brothers failed for similar reasons, but the damage was contained.

That’s absolutely not the case: Drexel Burnham failed because they were actually involved in utterly illegal activities in the junk-bond market, leading to big fines and their creditors’ shutting them off, while Salomon Brothers never actually even entered bankruptcy, though it was forced into being acquired by a similar scandal over the Treasury market. Bear and Lehman, meanwhile, failed because they took poorly assessed risky bets related to the housing market, a fundamental part of the economy in which much of the rest of the financial world was enmeshed, so their failure coincided with and worsened a global credit crunch. In other words, the distinction is that their failure by definition was contagious, while Salomon’s and Drexel’s weren’t. How on earth does one cite this as evidence of the importance of Glass-Steagall?

And further, while I don’t subscribe entirely to this theory, it’s worth pointing out that Bear and Lehman both lacked commercial-banking businesses, while most of the larger investment-banking firms that survived the crisis did. During the credit crunch that got most acute in September and October of 2008, the liquidity afforded by large amounts of commercial deposits — which investment banks couldn’t hold under Glass-Steagall — probably helped.

Further, the senators’ bill itself, in laying out its justification, emphasizes the idea that it would “reduce risks to the financial system by limiting banks’ ability to engage in activities other than socially valuable core banking activities” and make them less likely to engage in trades that aren’t in the interest of their customers. But it’s not clear how this is relevant to a Glass-Steagall wall: Commercial banks and investment banks both perform “socially valuable banking activities,” and both are quite capable of carrying out activities that aren’t in the interest of their customers.

I would note that there are actually some good arguments in favor of Glass-Steagall; Warren just basically didn’t make them. Luigi Zingales, a professor at UChicago’s Business School and a fellow at the Manhattan Institute, points out some of them here in the FT, suggesting that it’s a simple way to create a market with more, diverse participants, and to keep commercial banks and investment banks separate as a corporate matter so that they compete over their interests rather than collude (especially politically).