This post is part of a blogging series by economics students at the Presidio Graduate School’s MBA program. You can follow along here.
By: Lauren Wray
While there are a few things that folks of differing political persuasions might have in common with one another, there are not many. So I found it noteworthy when, going to dinner with my outspoken libertarian uncle, we both agreed that reinstating Glass-Steagall Act would be a huge step for fixing the banking mess of today. We were both chagrined that there has been very little buzz about actually reinstating this act recently in the US.
A quick refresher on the Glass-Steagall Act:
It separates commercial banks from investment banks, isolating the risk inherent in investment banks from the deposits of everyday consumers. ‘It was enacted as an emergency response during the Great Depression and made permanent in 1945. The Glass-Steagall Act was eviscerated in 1999 under criticisms that the boundaries it drew were outdated, and the change repealed the restrictions on bank and securities firm affiliations. More information can be found here.
That was as much as I knew about it, but I wanted to understand why my uncle, a libertarian hedge fund manager, was so keen on it. He explained what Glass-Steagall does for commercial banks is it keeps depositors money away from the risk associated with investment banks. But what does this mean for the investment banks and brokerages?
Glass-Steagall encourages and allows smaller brokerages to stay small, small enough to fail. Thomas M. Hoenig, the President of the Federal Reserve Bank of Kansas City in an Op-Ed for the New York Times explains it better then I can convey from our conversation:
“Taking similar actions today to reduce the scope and size of banks, combined with legislatively mandated debt-to-equity requirements, would restore the integrity of the financial system and enhance equity of access to credit for consumers and businesses. Studies show that most operational efficiencies are captured when financial firms are substantially smaller than the largest ones are today. These firms reached their present size through the subsidies they received because they were too big to fail. Therefore, diminishing their size and scope, thereby reducing or removing this subsidy and the competitive advantage it provides, would restore competitive balance to our economic system.”
Topically, in the last two weeks in the UK, an interim report was released by Sir John Vickers of the Independent Commission on Banking, recommending ‘ringfencing’ retail banks and making them hold onto more capital- in essence, what Glass-Steagall was doing in the US. The UK is strongly encouraging this type of reform. With this push from the other side of the pond for similar regulation, I hope that the Glass-Steagall Act moves back onto the agenda for financial reform in the US. And I am looking forward to having more economics conversations over family dinners in the future!
Lauren Wray is an MBA candidate at the Presidio Graduate School who enjoys good conversations, friends & family meals and good beer.