During a press briefing earlier this month, White House Spokesman Sean Spicer said the administration remained committed to a Trump campaign promise to restore Glass-Steagall, which effectively prohibits commercial banks from engaging in investment banking. The law was created in 1933, but most of it was rescinded in 1999. However unreliable Spicer has shown himself to be, bringing back the law would be a welcome move for anyone hoping to get tough on Wall Street's continuing risks.
Glass-Steagall was put in place after the Depression to ward off the economic wreckage of financial crises by requiring that banks either be a regular bank that takes in customer deposits or an investment bank that makes markets in securities. Bank regulators’ failure to enforce the law aided its demise, and Congress repealed the requirement for separation of the two types of banks during the Clinton Administration under the Gramm-Leach-Bliley bill.
Arthur Levitt, who ran the SEC at the time, told Frontline that pressures from the White House, the Federal Reserve and many lobbyists from the financial services industry, including a big push from the derivatives lobby, led to the reversal. The name of the Senate Banking Committee chair at the time, Phil Gramm, is on the repeal law, and together with his wife Wendy, the couple helped make possible Enron’s infamous use of derivatives that led to the energy company’s spectacular collapse in 2001. After Enron’s demise, although the huge risks in derivatives were known, banks continued to proliferate them, one of the proximate causes for the financial crisis in 2007.
That Glass-Steagall has not yet been reinstated speaks to the power of the financial services industry and the misguided faith in humans to self-regulate on matters conflicting with their immediate self-interest. Whether or not the Trump administration takes action, a bipartisan group of 26 members of Congress in February called for a return to Glass-Steagall. That’s not a surprise since the law's re-instatement was on the 2016 party platforms of both the Democratic and Republican parties.
As I’ve argued before, a return to Glass-Steagall is not sufficient to prevent future crises, but it is necessary. It's impossible for managers and boards to do their jobs effectively in overseeing banks with both investment and regular banking under the same roof, each with such distinct risk appetites, divergent cultures and differing stakeholder expectations.
At Citigroup, after the Salomon Smith-Barney merger, for example, the aggressive, transaction-oriented nature of investment banking ran roughshod over the more genteel business of corporate relationship management: relationships were out and quick bucks were in. And along the way, the company lost one of its greatest attributes: a culture of strategic inquiry.
We have seen multiple examples of the combined banks’ customer mal-treatment and malfeasance in the foreclosure crisis. Think J.P. Morgan and Bank of America to name a couple. Then fast-forward to today and look at the Wells Fargo fake account scandal last year. Like Citi, Wells Fargo
is another case where the culture of the growing investment banking business appears to have bled over to the regular bank. It’s unreasonable to expect a management team to embody two competing cultures at once. At Wells, regular customers were harmed, which led to calls to break up the bank. It remains to be seen what could happen down the road, but for now, The LA Times reported last week that Wells Fargo has adopted a divide and conquer strategy meeting with Republicans in December while while rebuffing attempts by Democrats to dialogue.
Restoring Glass-Steagall is relatively straightforward, while other alternatives like going to shareholders — bank by bank — to force separation are much more time consuming and tedious. But since Congress hasn’t acted, Public Citizen’s Financial Policy Advocate Bart Naylor, who supports full separation and owns shares in Citigroup, has a proposal on Citigroup’s ballot this Spring. Shareholders will have the opportunity to vote on whether to encourage the Citi board to “explore options to split the ﬁrm into two or more companies,” with one to house investment banking and a separate company to perform “basic business and consumer lending.”
Glass-Steagall is also more effective than structures that might mimic it. During my talk last week with Tom Hoenig, the Federal Deposit Insurance Corporation (FDIC) vice chair told me that he also has seen how the risky culture of investment banking overran the relationship culture of regular banking after Glass-Steagall.
And he continues to be concerned that the largest, riskiest banks could again take down the economic system, leaving taxpayers to clean up the mess. But unsure that Congress will pass Glass-Steagall, he’s suggested a complex alternative, which would not break the largest banks in two, but would call for the bank holding company (with its existing board and stock) to create two separate businesses (a commercial bank and an investment bank), each with separate stock and separate boards. To its credit, the idea is that the new boards would not have members who also serve at the holding company level. To its detriment, however, the plan relies on markets to effectively monitor the new individual stocks with no promise of shareholder voting rights or say on pay or election of directors at the underlying companies. The holding company board would likely control appointment of board directors to the investment banking and regular banking boards, Hoenig says.
Glass-Steagall’s reinstatement is also important because it makes it easier to comply with existing requirements and other needed banking reforms (related to capital levels and derivatives). With Glass-Steagall, we could expect better living wills and stress tests, as the entities would be separate and less complex. And implementing capital increases (that both Hoenig and Naylor support, although at different levels) and addressing the key ongoing concerns of derivatives (through improvements in capital calculations as Hoenig recommends and limiting their use as Naylor advocates) would also be easier to implement.
Of course, reinstating Glass-Steagall is bound to elicit cries of victimization from financial institution CEOs and their lobbyists. But that’s to be expected. I don’t personally know anyone who relishes a restructure imposed from the outside that might narrow his power. Do you?
Eleanor Bloxham is CEO of The Value Alliance, an independent board education and advisory firm. She is the author of two books on corporate governance and valuation.