Repealing of Glass Steagall a Mistake Essay

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Introduction



I believe that repealing Glass-Steagall was a mistake. There are several reasons for this, not the least of which is the critical, fundamental difference between investment banking and retail or commercial banking. But the protections that Glass-Steagall put into place guarded against issues that were relevant in the 1930s but never stopped being relevant. The financial crisis of 2007-2009 is strong evidence that the need to protect against commercial banking volatility is more important that the need to allow investment banks to "innovate". This paper will illustrate the case that repealing Glass-Steagall was a mistake.

Glass-Steagall Act



It is important to understand the environment in which Glass-Steagall was passed in order to understand the merits of the Act, and evaluate whether it stands the test of time and should have been left in place. Prior to Glass-Steagall, the US economy was subject to a multitude of economic shocks. Under conditions of laissez-faire management, the economy went through a number of boom-bust cycles. Dating as far back as the Dutch tulip boom in the 17th century, to booms associated with the opening of new markets (i.e. South Seas), finding new deposits of gold, to railroads, economic activity followed boom-bust cycles (Bordo, 2003). Marx predicted that these cycles would continue if capitalism were to be left unfettered.



Following the latest bust, the stock market crash of 1929, the Glass-Steagall Act was passed in order to restructure the banking system (Heakall, 2015). Setting up a structure for the US economy was a work in progress – indeed at that time this was a work in progress for many industrialized nations. Some of the other, prior, steps had been the creation of Federal Reserve and the introduction of monopoly protections under the Clayton Act. The objective of these different elements was to bring about some semblance of control over capitalist activities, under the recognition that when busts occurred, many people suffered, including many who were not a part of the boom in the first place. The Great Depression was another recognition of this fact as millions were thrown out of work with no social protections.



Glass-Steagall therefore did a couple of things, owing to the separation of investment and commercial banking. By putting strict limits on the amount of profit banks in either sector could earn in the other, the Act focused each bank's attention on its core business.

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By doing so, it recognized the fundamental reality that investment and commercial banking are very different from one another.



Commercial banking is an inherently stable business. Consumers need to have commercial banks that are reliable in terms of holding savings and borrowing to buy property. Small business relies on these banks as well, for loans and start up financing. When commercial banks are stable, this creates an atmosphere of confidence in the economy. The reality is that when they are unstable, people are more hesitant to deposit money, if they think that there is a chance they could lose that money. With no deposits, banks cannot lend, and that means no mortgages, car loans, or small business loans, and that would be incredibly detrimental to the economy. One of the key objectives of Glass-Steagall was to ensure that there would be stability in the economy via stability in the commercial banking system.



Investment banks, of course, have an entirely different business model. They take companies public, and work on mergers and acquisitions. As such, investment banks not only work on bigger deals, but they take on inherently more risk in their businesses. Over time, investment banks have become incredibly creative when it comes to structuring deals and investment products alike, something that the repeal of Glass-Steagall didn't take into account. While there were still limitations, sometimes fairly strict, on the activities of investment banks, they are clearly more volatile by the nature of their work, relying on large deals rather than a large amount of smaller deals. Commercial banks are inherently better diversified than investment banks. The high degree of both volatility and complexity in investment banking makes it a poor match for commercial banking.

Outcomes of Glass-Steagall



Following Glass-Steagall, there were few economic shocks. There were surely other factors involved, but not until the oil price shocks of the 1970s were there strong shocks to the US economy – for a period over 25 years there was stability. The reality is that the distinction between….....

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References

Bordo, M. (2003) Stock market crashes, productivity boom busts and recessions: Some historical evidence. Rutgers University. Retrieved October 28, 2017 from https://www.cfr.org/content/thinktank/Depression/Bordo_2.pdf

CFtech.com (1998). Understanding how Glass-Steagall Act impacts investment banking and the role of commercial banks.
CFTech.com. Retrieved October 28, 2017 from http://www.cftech.com/index.php/the-brainbank-archive/special-reports/404-understanding-how-glass-steagall-act-impacts-investment-banking-and-the-role-of-commercial-banks

Crawford, C. (2011) The repeal of the Glass-Steagall Act and the current financial crisis. Journal of Business and Economics Research Vol 9 (1) 127-133.

Heakall, R. (2015) What was the Glass-Steagall Act? Investopedia. Retrieved October 28, 2017 from http://www.investopedia.com/articles/03/071603.asp

Marx, K. (1867) Das Kapital

Olson, (2002) Remarks by Governor Olson. Federal Reserve Bank of St. Louis. Retrieved October 28, 2017 from http://www.investopedia.com/articles/03/071603.asp
 

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