Recently, in an interview for
Inc. magazine, former President Bill Clinton stated "Look at all the grief I got for signing the bill that ended Glass-Steagall. There's not a single, solitary example that it had anything to do with the financial crash." That's not the case, at all.
The Glass-Steagall Legislation, officially known as the Banking Act of 1933, was a law passed in the 1930s midst the Great Depression. It is named after after its co-authors, Senator Carter Glass and Representative Henry B. Steagall (both Democrats). This legislation essentially did two major things: it established the Federal Deposit Insurance Corporation (FDIC) and placed a separating wall between investment banking and commercial banking. Provisions also included the establishment of the Federal Open Market Committee (FOMC), Regulation Q (which included lowering competition between commercial bank, limiting investment practices deemed as high risk, established ceilings on interests), and restricted speculation (in essence, limiting "speculative trading or carrying" of securities and real estate and limiting the amount in loans a bank of the Federal Reserve could lend). The law also called for limiting Federal Reserve member banks in acting as brokers or dealers for lending.
This law was definitely a move in the right direction for many years even after its enactment. Separation of commercial banking and investment banking really is just common sense. Why would you want investors gambling with your hard earned money, essentially playing risk with your earnings? It is as Senator Warren says: commercial banking should be "plain, old, boring banking." If a wall had been set between commercial and investment banking, we would not have seen a massive bailout because those deposits are federally insured.
The law's after effects contributed to a relatively stable financial system. As Robert Reich, professor of economics and 22nd Secretary of Labor, states:
"For more than six decades after 1933, Glass-Steagall worked exactly as it was intended to. During that long interval few banks failed and no financial panic endangered the banking system."
In fact, it was only when we started to de-regulate that we saw some bank failures (not on a cataclysmic scale, however). The Savings and Loan (S&L) crisis serves as a
strong example of this.
In 1999, under then President Bill Clinton, the Gramm-Leach-Bliley Act (officially known as the Financial Services Modernization Act of 1999) was passed. This law repealed the most crucial portion of Glass-Steagall: separation of investment and commercial banking. This law allowed banking entities, securities entities, and insurance companies to participate in investing, commercial, and insurance functions simultaneously.
How does this relate to the 2008 crisis? It relates very strongly with the 2008 crisis? AIG, one company that was bailed out in the 2008 financial crisis, took a major role in the crisis and the bailout that came with it. AIG, for all intents and purposes at the time, could be classified as a bank. AIG was involved in credit default swaps. In layman's terms, credit default swaps are agreements that basically say sellers will pay the buyer if something goes haywire in the deal. It was discovered that nearly $441 billion in securities had a AAA rating (the highest possible rating in a credit report, saying this is a safe deal). Low and behold, however, $57.8 billion of those supposed AAA securities were actually supported by subprime loans. This was a primary cause of AIG's bankruptcy. Here's a perfect example of how an insurance company took on banking functions and failed. Had Glass-Steagall been in place, AIG would not have attained this sort of power. Gramm-Leach-Bliley forbid the Federal Reserve from regulating any insurance holding companies.
Let's look at another major contributor to this crisis: Citigroup. Citigroup had one of the worst impacts on the 2008 financial crisis because of its contribution to the subprime mortgage crisis. Richard Browen, Citigroup's chief underwriter for lending, stated:
“In mid-2006, I discovered that over 60 percent of these mortgages purchased and sold were defective,” Bowen testified on April 7 before the Financial Crisis Inquiry Commission created by Congress. “Defective mortgages increased during 2007 to over 80 percent of production.”
As late as 2012, Citibank was still involved in legal disputes, proposing a settlement of
$590 million. Take into account, Citi received a total of
$476.2 billion, making that "settlement" rather sweet for them and pretty lousy for the taxpayer. Because of the securities that Citigroup invested in and the poor quality control standards, risk kept accumulating in the system, ultimately to the point of financial collapse. Take into account, Citigroup is a bank where people deposit their money. Under the Glass-Steagall provision, this high risk and predatory activity was simply impermissible.
The financial collapse back in 2008 had a lot of factors that resulted in the depressed economic conditions. To say, though, that repeal of Glass-Steagall did not contribute to the collapse is flat out false. History repeated itself from the 1930s. Financial lawlessness and lack of common sense regulation resulted in both the depression and recession. If we are to learn an essential lesson from history it is this: entities that control a sizable portion and stake in the worldwide economy need to be watched very carefully. It is clear, time and time again, that these financial institutions do not play fairly when given the chance. Why should we let them? Simply put, we shouldn't. A market can only be truly free if the system safeguards the people with reasonable checks and balances and pursues justice when an entity commits illegal financial practices.