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Did the Gramm-Leach-Bliley Act cause the housing bubble?
No. That is one common myth among the progressive left. Because it involves financial deregulation and the unpopular Phil Gramm, the Act is vilified and assumed to be part of a broader chain of evil events. Here are some of the articles which promulgate the myth that the Act caused or helped cause the housing bubble. One version of the claim originates with Robert Kuttner, but if you read his article (and the others) you'll see there's not much to the charge. Kuttner doesn't do more than paint the Act as part of the general trend of allowing financial conflicts of interest.
Most of all, the Act enabled financial diversification and thus it paved the way for a number of mergers. Citigroup became what it is today, for instance, because of the Act. Add Shearson and Primerica to the list. So far in the crisis times the diversification has done considerably more good than harm. Most importantly, GLB made it possible for JP Morgan to buy Bear Stearns and for Bank of America to buy Merrill Lynch. It's why Wachovia can consider a bid for Morgan Stanley. Wince all you want, but the reality is that we all owe a big thanks to Phil Gramm and others for pushing this legislation. Brad DeLong recognizes this and hail to him. Megan McArdle also exonerates the repeal of Glass-Steagall.
Here is a good critique of GLB, on the grounds that it may extend "too big to fail" to too many institutions. That may yet happen but not so far.
The Act had other provisions concerning financial privacy.
Maybe you can blame some conflict of interest problems at Citigroup and Smith Barney on the Act. But again that's not the mortgage crisis or the housing bubble and furthermore those problems have been minor in scale. Ex-worker has a very sensible comment. The most irresponsible financial firms were not, in general, owned by commercial banks. Here's lots of informed detail on GLB and the bank failure process. Here is another good article on how GLB didn't actually change Glass-Steagall that much.
Here's a Paul Krugman post on GLB; he attacks Phil Gramm but he doesn't explain the mechanism by which GLB did so much harm. The linked article has no punch on this score either, although you will learn that Barack Obama has scapegoated GLB, again without a good story much less a true story.
I may soon cover the Commodity Futures Modernization Act as well.
Posted by Tyler Cowen on September 19, 2008 at 06:48 AM in History | Permalink
Comments
The majority of left-wing blogs are absolutely loving the financial crisis.
It's the rapture of the marxists.
Posted by: Heh at Sep 19, 2008 7:37:29 AM
How about Tyrone's take on the whole mess?
Posted by: Real Andrew at Sep 19, 2008 8:33:29 AM
From Ex-Worker's comment:
"As a policy argument, those who reflexively blame all ills on vague themes like "deregulation" without understanding the industry might consider claiming "a special sort of stupid" from tongue in cheek conspiracy theorists."
Dead on!
Posted by: Tom at Sep 19, 2008 8:47:15 AM
I'd love to read a non-politicized piece - in-depth with specifics - not about the failures of the past per se but what the ideal future landscape looks like for our financial markets, taking into account what we have learned from this year's events.
Things like:
1) How to handle the ratings of securities/financial instruments. Can we admit this system is broken?
2) Financial instruments themselves - are the gordian knot of counterparty interdependence and the securitization of securitizations too complex for banks themselves to understand? Should interdependence and complexity be limited - by regulation or otherwise (e.g. financial institutions' risk management groups) or will this inhibit growth? Would better disclosure be of help?
3) Leverage. Should this be limited, either by regulation or internally? Does it need to be better disclosed?
4) Incentives, a subject near and dear to Tyler's heart. If we reward risky (reckless?) investment strategies, what results can we expect? Should boards tie executive compensation to better/different performance metrics?
5) The roles of the Fed and the Treasury, avoiding the political angle, should be what exactly?
Is it possible to look at this holistically without rancor or posturing?
Posted by: meter at Sep 19, 2008 8:58:05 AM
So, let me get this straight. If GLB caused the problem, and because of the problem we are forced to take emergency measures and perform massive mergers, we should be thankful that GLB allows that to happen.
That is a really circular argument. I'm glad we're able to make even worse decisions during a crisis because of the bad decisions in the first place.
Geebus.
Posted by: Hal at Sep 19, 2008 9:05:14 AM
Most importantly, GLB made it possible for JP Morgan to buy Bear Stearns and for Bank of America to buy Merrill Lynch. It's why Wachovia can consider a bid for Morgan Stanley.
When you cut a hologram into quarters, each part of it gives the whole picture but with reduced focus. The smaller the remaining hologram the more out of focus the whole picture gets.
From one out-of-focus public view, a whole lot of the current problem is that we have a collection of failing institutions that are Too Big To (be allowed to) Fail.
You talk like it's a good thing to make even bigger TBTF companies.
Can you find some way to justify that?
It reminds me of an old BC comic strip. The caveman who had been crafting square wheels came up with a triangular wheel.
"Why is that better?"
"See?! One less corner!"
Posted by: J Thomas at Sep 19, 2008 9:05:24 AM
I'm curious what people think about scrapping the T+3 settlement period for US stocks?
I argue that instant settlement is more transparent, "honest", and hopefully less prone to tactics such as naked short selling.
It should be easily within the realm of current technology to guarantee the asset is available at the time of the trade.
Posted by: Jeff Garzik at Sep 19, 2008 9:12:15 AM
Look at the failures, to this point none of them have been unified big banks YET.
They have been
1) Two quasi government agencies not regulated as banks.
2) Three Investment Banks without comercial banking.
3) An insurance company (not a bank)
And the banks that have been in the most trouble Wachovia, WaMu etc do not combine investment banking and traditional banking to a large extent.
Who has held up? BofA, JPM, Citigroup. Big unified banks.
I can't find much to blame in GLB.
Posted by: eccdogg at Sep 19, 2008 9:33:07 AM
GLB is getting boring.
I am anxiously awaiting this post on the CFMA! I guess the CDS regulation part is getting the most attention but I'm always up for discussion of Section 2(h)(3)...aka the Enron Loophole.
Posted by: pants at Sep 19, 2008 9:47:32 AM
Most importantly, GLB made it possible for JP Morgan to buy Bear Stearns and for Bank of America to buy Merrill Lynch.
What Hal said. I have no opinion on what role GLB played in the current crisis, but obviously if it helped cause the failures (or near-failures) of Bear and Merrill, as critics suggest, then arguing from the fact that it also made possible the specific rescue mechanism that played out (not the only possible one, as we're now seeing, by the way) is just naked bootstrapping.
Maybe the SEC should ban that too.
Posted by: Glenn at Sep 19, 2008 10:27:26 AM
So, the repeal of the law allows major firms like JP Morgan to take on obviously bad assets like Bear Stearns.
I am confused as to how this is a good thing?
Posted by: Robert Olson at Sep 19, 2008 10:29:21 AM
I have listened to Michael Greenberger discuss these issues more convincingly. There just isn't enough evidence behind what you are saying for me to be convinced the all these various acts especially the GLB act and the subsequent CFMA in 2000. Greenberger worked at the CFTC and seems to have witnessed the groundwork for these failures from the inside. There are a lot of economists and policy makers who do regard these acts of Congress along with total lack of oversight as enablers to this meltdown.
Posted by: olana at Sep 19, 2008 11:18:13 AM
If GLB caused the problem, and because of the problem we are forced to take emergency measures and perform massive mergers, we should be thankful that GLB allows that to happen.
But that whole argument hinges on the premise that GLB "caused the problem," which neither you nor anyone else has remotely established. So your attempt at cleverness doesn't even get off the ground. (Same goes for the commenters over at DeLong's place who make the same argument.)
Posted by: SB at Sep 19, 2008 11:31:23 AM
You may well be right re the wisdom of GLB but defending it by reminding us that "Citigroup became what is today because of it" would seem to be evidence against your proposition
Posted by: cmurphy at Sep 19, 2008 12:52:26 PM
Here is a good critique of GLB, on the grounds that it may extend "too big to fail" to too many institutions. That may yet happen but not so far.
The Wilmar critique, which was probably written 2002-2003 pretty much hits the nail on the head and I am not sure why you bury it the way you did.
Complex banking organizations will take advantage of TBTF and assume too much risk. Regulators will look the other way. Seems to me pretty much what happened.
Posted by: lxm at Sep 19, 2008 3:24:20 PM
"Complex banking organizations will take advantage of TBTF and assume too much risk. Regulators will look the other way. Seems to me pretty much what happened."
Because GLB did not apply to the firms that did this and failed.
GLB did nothing to help AIG, Bear, Fannie, or Freddie become too big to fail.
None of them combined investment and comercial banking which is what GLB allowed.
They could have had the same problems with or without it.
Posted by: eccdogg at Sep 19, 2008 3:58:07 PM
Robert Olson,
Why should the government ban JP Morgan from buying whatever assets it wants to buy? Particularly in the case of buying assets from an institution that had a liquidity crisis?
Posted by: CJS at Sep 19, 2008 4:07:42 PM
I'm curious what people think about scrapping the T+3 settlement period for US stocks?
I like the idea. We could have a float measured in minutes or seconds.
I argue that instant settlement is more transparent, "honest", and hopefully less prone to tactics such as naked short selling.
I see nothing wrong with it. Make the sale whenever the payment goes through. Ah, that means we wouldn't allow a float for payments either, right? You have your funds deposited with your broker and they go where they're supposed to instantly, and everybody admits they've gone through?
Posted by: J Thomas at Sep 19, 2008 7:55:55 PM
Its easy for the marxists to be in rapture over instability in the production and distribution of wealth. Their ideas have never produced any wealth to speak of.
Posted by: Al Brown at Sep 19, 2008 9:14:12 PM
/Most of all, the Act enabled financial diversification and thus it paved the way for a number of mergers./
Why the general sense that huge institutions are an improvement? They sure haven't helped "us." (who are not bankers)
Don't we just get institutions that are "too big to fail" and have to be bailed out by the taxpayers? What do any of you economists say about the huge transfer of wealth that has gone on in the past 30 years - creating a much more polarized society in the US? Questions from a non-economist, obviously!
/we all owe a big thanks to Phil Gramm and others for pushing this legislation./
I think in the coming days you might see yourself in the minority on this point. There is going to be a real witchhunt.
Posted by: at Sep 20, 2008 10:13:04 AM
Suppose it was smaller institutions, would that help?
Once upon a time we had a lot of small savings-and-loan companies that got in trouble. It could be argued that they got into trouble largely because of federal regulations that prevented them from succeeding.
So then the federal government relaxed the regulations that kept them from doing extra-risky transactions. Apparently the theory was that they could take risks and win and work their way out of the hole that way.
So when the risky stuff went bad, they were *really* failing. It was a great big problem because even though no one of them was that big they still made a great big difference collectively, and their collective failure would hurt many millions of voters.
Is it a choice between having many small companies fail with disastrous consequences, versus a few large companies?
Wouldn't it be better if we could avoid the massive failure in the first place, rather than just decide how to distribute the consequences after it happens?
Posted by: J Thomas at Sep 20, 2008 10:27:43 AM
Europe has no Glass-Stegall. In fact they never had it and their banks have not failed. I think the evidence is clearly indicating that universal banking i.e. combined insurance, banking and securities underwriting is the way to go. We have had two big financial crises in recent history, the savings and loan crisis and the current mess. In both cases the institutions that have failed are basically the products of Depression Era banking laws.
Posted by: assman at Sep 20, 2008 1:34:46 PM
Citi is still in trouble. I wouldn't use it as proof of success. But what concerns me is how many of these bailouts from the gov't are justified in part by the idea that these firms are "too big to fail." It seems to me that these mergers you speak of only create more such firms that are too big to fail. I will agree that these more diversified companies have a lower chance of failing, but when they do, it can almost be guaranteed that the gov't will have to bail them out. We risk creating an entire industry that is effectively government backed. It only follows that with this backing, we shouldn't be surprised to see even riskier behavior from these firms in the future (once the present situation calms down and responsibility subsides along with fear).
As for the thesis about the Gramm bill. Is it to blame? No, I don't think so. I'm not arguing that.
I just have fears about this consolidated market place we're creating.
Posted by: Greg at Sep 20, 2008 4:56:18 PM
http://market-ticker.denninger.net/
Posted by: at Sep 20, 2008 9:27:46 PM
J Thomas writes "You talk like it's a good thing to make even bigger TBTF companies."
I was also wondering about that. Isn't BOA/Merrill now one of those TBTFs?
Will these new, larger entities have more oversight?
Posted by: Steve J. at Sep 20, 2008 9:47:09 PM
