Wednesday, July 25, 2012

Did the Repeal of Glass Steagall Cause the Financial Crisis?

Sandy Weill, former CEO of Citigroup caused a stir today by commenting that Glass Steagall should be reinstated.  Since he is the person who pioneered the integrated banking model, the comments are shocking.  The comments are puzzling too because even if one thinks that separating commercial and investment banks would create more stability in the long term, it's not entirely clear that the financial crisis stemmed directly from the integration.

Empirically, not a single integrated bank failed in 2008/2009.  Lehman and Bear were not commercial banks, and Indymac and WaMu weren't investment banks.  AIG, Fannie and Freddie were not banks of any sort.  In fact, Goldman and Morgan Stanley (along with some insurance companies) were saved by converting to bank holding companies so that they could access liquidity at the Federal Reserve.

The argument for a separation of commercial and investment banking activities perhaps stems from the belief that depositors ("main street") need to be protected from the volatility of securities markets. However in today's economy, only a tiny portion of household savings is held as deposits anyways, so the savings of main street are far from insulated from a collapse of an investment bank (even if it were separated from the commercial banking system).

Below is a list of bank failures in 2008.  Note that Lehman, Bear, AIG, Fannie and Freddie are not on the list.  In all, 447 banks have failed between 2008-2012.  The vast majority were community banks that were in "less risky" lending businesses.  The fact is that banking is risky business in any form.

2008 Bank Failures

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