Money Matters
5:00 am
Tue June 12, 2012

Can we regulate our way out of the financial crisis?

When it comes to assigning blame for the 2008 financial meltdown, some fingers are pointing at the 1999 repeal of the Glass-Steagall Act. But others aren’t so sure.

Financial commentator Greg Heberlein and KPLU’s Dave Meyer look at banking regulations on this week's Money Matters.

Four years after the 1929 crash, Congress passed the Glass-Steagall Act. It created the FDIC to provide insurance on bank deposits. Over time, its many provisions were interpreted to keep investment companies and banks separate, and to prevent those institutions from using customer money to invest in a bank’s own account.

Because the lines between banks and investment companies already had blurred, Congress in 1999 repealed the act. Banks could run brokerages.

For some, this raised a huge red flag.

Some critics said the repeal changed the banking culture. With better profits on the brokerage side of their business, banks began to make higher-risk moves in the brokerage side.  

Another consequence, according to critics, was that the merging of banks and brokerages created institutions that were "too big to fail". The Federal Reserve Board Chairman at the time, Alan Greenspan, said allowing a bank-investment company mix would expand the federal deposit insurance program to riskier investments. 

Glass-Steagall apparently did its job. The nation avoided a crisis for 60 years. Only after the act was gutted did trouble occur.

But those in favor of deregulation say that Glass-Steagall would not have prevented shoddy mortgage lending. Combining bad mortgages and selling them to clients was not addressed by the act.

President Bill Clinton, who engineered the 1999 repeal, said the new act actually helped during the crisis, allowing banks to buy troubled investment companies.  

Well-known financial author, Martin Mayer, took the middle position, asserting that loosening Glass-Steagall did contribute to the crash, but the mingling of banks and commercial banks already had been launched while Glass-Steagall was in full force.

Recent attempts to reinstitute Glass-Steagall’s key provisions either have failed or are in limbo. The Obama administration says the absence of Glass-Steagall did not cause the crash.

Legislation already passed since the 2008 crash would limit some of the riskier actions taken by banks.

Regulating the financial industry is complicated, and there are very convincing arguments on all sides of the debate. Greg Heberlein doesn't claim to have the answers, but wants to leave you with the following points:

Controlling the wildly expanding derivative market may lessen financial volatility and reduce the odds of another crash. Some restrictions already have been adopted to address this trillion-dollar issue.

Limits on mingling customer money with an institution’s own investments are in place. Better oversight might be necessary.

The political division in Congress means it is unlikely to commit one way or the other. One effort to restore Glass-Steagall has been proposed by two Senators on opposite ends of the spectrum, Washington State’s Maria Cantwell and Arizona’s John McCain. They’ve been called the odd couple. The outlook for their proposal is less than rosy.