Repealed Glass-Steagall Act Played a Role in Financial Meltdown

When President Bill Clinton signed legislation to repeal the Depression-era Glass-Steagall Act in 1999, he handed Wall Street  a victory that likely contributed to the recent financial meltdown. Glass-Steagall’s repeal eliminated barriers between normal banking activities – deposits and lending – and riskier areas such as derivatives trading.

“The capital-market rules are going to change,” says Brad Hintz, an analyst at Sanford C. Bernstein & Company in New York.  “It’s going to be much more difficult to trade in the illiquid parts of the market” beyond corporate and government bonds, as well as to finance investments.

President Barack Obama is working with his advisors and Congress to fill the regulatory void that Glass-Steagall’s repeal left.  Former Federal Reserve Chairman Paul Volcker, now a financial advisor in the Obama administration, prefers a “two-tier” financial system that limits risk taking.  Current Fed Chairman Ben Bernanke has increased surveillance of the systemically important firms and believes that these companies require “especially close oversight.”

To quote then-candidate Obama in a spring of 2008 speech, “A regulatory structure set up for banks in the 1930s needed to change.  But by the time the Glass-Steagall Act was repealed in 1999, the $300 million lobbying effort that drove deregulation was more about facilitating mergers than creating an efficient regulatory framework.”

The result?  Commercial banks seeking to compete with investment banks took on significant trading risks and created off-balance-sheet financing methods to reduce the capital they required to avoid loan losses.  At the same time, investment banks started lending more aggressively to companies and increased their own borrowing to purchase securities or real estate.

All that has occurred clearly demonstrates the need for effective new regulation.