Professor Misstates Glass Steagall History?
By Staff News & Analysis - January 18, 2013

Why No Glass-Steagall II? … Eighty years ago this month, Ferdinand Pecora, the cigar-chomping former assistant district attorney for New York City, was appointed chief counsel for the US Senate Committee on Banking and Currency. In subsequent months, the hearings of the Pecora Commission featured many sensational revelations about the practices that led to the 1930's financial crisis. – Project Syndicate

Dominant Social Theme: It is simply common sense. If banks can't gamble their own money in the big casino of the global stock market, they won't go broke.

Free-Market Analysis: Barry Eichengreen is a professor of economics and political science at the University of California, Berkeley, and a former senior policy adviser at the International Monetary Fund. So why does he, in our view, misrepresent the history of the financial industry in this article posted over at Project Syndicate?

He writes about the US Glass-Steagall Act, which separated commercial and investment banking and suggests that it should be reinstituted. He is a fan of Ferdinand Pecora, whom Franklin Delano Roosevelt picked to head up the 1930s hearings that led to various regulatory impositions including the Securities and Exchange Commission. True, he doesn't mention that there is in force a Volcker Rule currently … but maybe that's because the Volcker Rule is such a weak version of Glass-Steagall that it's not worth commenting on.

The big issue as regards the Volcker Rule is that it is only in force for 60 days. And thus, banks like Goldman Sachs can restructure their proprietary trading so that their trades are set for longer than 60 days and thus not break the rule. Ironically, trades can be removed before 60 days without breaking the rule, so far as we can tell. It's not much of an impediment. Here's some more from the professor's editorial:

Glass-Steagall … created federal insurance for bank deposits. With unit banking (in which all operations are carried out in self-standing offices) viewed as unstable, banks were now permitted to branch more widely. Glass-Steagall also strengthened regulators' ability to clamp down on lending for real-estate and stock-market speculation.

The hearings also led to passage of the Securities Act of 1933 and the Securities Exchange Act of 1934. Securities issuers and traders were required to release more information, and were subjected to higher transparency standards. The notion that capital markets could self-regulate was decisively rejected …

Another popular argument for the success of 1930's reform is that Congress had already agreed on a diagnosis of the problem and could build on its own earlier efforts to treat it. Senator Carter Glass had been pushing for years for more permissive branching laws and centralized supervision of banks. He had already introduced a bill containing several such measures in January 1932 …

Ultimately, the explanation for the passage of far-reaching financial reform can only be the severity of the crisis. In the 1930's, the Great Depression brought the entire economy to its knees. The need for root-and-branch reform was undeniable. After 2008, by contrast, policymakers succeeded in preventing the worst, which ruled out the sense of urgency that surrounded the Pecora Commission hearings. The ultimate irony is that this very success led to less reform.

Leave aside the professor's strong supposition that the 1930s security reforms constituted "a success" and one is still left with a curious presentation of history. He writes that the Great Depression brought "the entire economy to its knees." Not so fast …

Actually, it was the Federal Reserve's illegal overprinting of dollars that led to the stock market crash and subsequent economic contraction. This contraction would have been over quickly had Roosevelt not begun a decade-long attack on free markets, loading them down with taxes, regulations and tariffs.

It is simply sad that the economics profession is filled with intelligent people who have the capacity to carry two completely contradictory ideas in their heads at the same time. The first idea is that regulation works. The second is that price fixing doesn't.

Ask any savvy observer of markets and economic activity if laws restricting people's freedom of action when it comes to buying and selling are a good idea, and he will probably say no. But at the same time, this person may well espouse legislation that amounts to the same thing.

Regulations ARE price fixes. They don't work the way they are expected to because they cannot. They always encourage activity that is different from what was anticipated because of what Austrian economists call "human action." Confronted with government mandates forbidding a certain activity, people will seek a way around it.

In the case of Glass-Steagall, one could argue that it did not appreciably "calm" the markets in the 20th century because the problem it was addressing had to do with Fed overprinting of money, probably on purpose to get rid of the gold standard.

Thus, what Congress should have removed was the central bank, not the ability of this or that private bank to trade proprietarily, something they'd done successfully for decades.

After Thoughts

The financial history related in this article is well known by now. It is all over the Internet. At the very least, the professor should take the time to rebut it before advancing an alternative view of history that seems more like a power elite promotion than a clear-eyed view of the evolution of US markets.

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