Glass-Steagall Is Mostly A Red Herring

Something I’ve heard from participants in the 99 Percent Movement is a revival of interest in rescinding the repeal of the 1932 Glass-Steagall Act. I think this is largely a misunderstanding, and it’s a actually a different — slightly more obscure — banking regulation from the same era that people are interested in.

First off, what did Glass-Steagall do? Well it did a number of things (like establish the FDIC) that were never repealed. But the rule that was repealed in the 1999 Gramm–Leach–Bliley Act were restrictions on the same holding company owning a bank and owning other kinds of financial companies. The thing about this is just that there’s really nothing in particular about co-ownership that you can point to as having been a problem in the financial crisis. And if anything that fact seems to indicate that the repealers were right to think there’s no special problem here — even in a huge financial crisis combined financial firms worked no worse than other kinds.

But wasn’t the repeal of Glass-Steagall the key to the emergence of these gigantic banks with huge political influence? Certainly it helps. If you’re a bank, plus some other large enterprise, then you have more clout than a mere bank would have. But the bank-qua-bank can’t get any bigger by merging with something that’s not a bank. What really did keep banks small was that when the 1927 McFadden Act let nationally charted banks get in the branching game, it prohibited them from operating branches in more than one state. What’s more, states were allowed to put tighter restrictions than that on branching. The “one state only” rule is totally arbitrary. There’s no principled reason you should be allowed to have branches in Manhattan and Buffalo but not Manhattan and Newark, or that it’s okay to work with a local branch of a very large bank in Yuba City but not in Utah. But it does limit the overall size of banks pretty severely. California, Texas, and New York banks would be kinda big and banks in most of the country would be quite small. And the fact that the rule is so plainly arbitrary makes it relatively easy to enforce. Since it simply piggybacks on existing lines rather than claiming to be some fine tuned optimization, it’s relatively difficult to game the system without people noticing.

Federal regulators started to relax this rule in the 1980s and it was firmly repealed in the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. It seems to me that if you want to look at a piece of 1990s financial deregulation that set off waves of bank consolidation, this is where you want to look. But was it a good idea? More on that later.