Afternoon Must-Read: Barry Eichengreen: Financial Crisis: The Banking Rules that Died by a Thousand Small Cuts

…was not brought on by the lack of Glass-Steagall per se but instead by a whole set of measures that loosened regulation. The end of Glass-Steagall was simply emblematic…. It all started in 1980 with the abolition of Regulation Q…. That led to a cascade of unintended consequences…. The Garn-St. Germain Act of 1982 allowed S&Ls to engage in a range of commercial banking activities….

In response to a petition from J.P. Morgan, Bankers Trust, and Citicorp, the Federal Reserve creatively reinterpreted Glass-Steagall in December 1986 to allow commercial banks to derive up to 5% of their income from investment banking activities…. In 1987, over the opposition of Fed Chair Paul Volcker, the Federal Reserve Board authorized several large banks to further expand their underwriting…. Under Volcker’s successor, Alan Greenspan, the Fed then allowed bank holding companies to derive as much as 25% of their revenues from investment banking operations….

Investment banks had first been allowed to expand when, in 1970, the ban on publicly listing their shares was lifted. The response took time to gather steam…. In 1997, Morgan Stanley… merged with Dean, Witter, Discover & Co., a brokerage and credit card company…. Bankers Trust acquired Alex. Brown & Sons, an investment and brokerage firm. The consolidation… threatened to put banks at an even bigger disadvantage. So the banks responded by lobbying even more intensely for the removal of the remaining restrictions on their operations.

By the 1990s, then, the Glass-Steagall Act was already significantly weakened. The fatal blow was struck in 1998 when Citicorp moved to purchase Travelers…. The chairmen and co-CEOs of the merged company, John Reed and Sandy Weill, mounted a furious campaign to remove Glass-Steagall’s nettlesome restrictions before the two-year window closed. Their arguments received a sympathetic hearing from Alan Greenspan’s Fed, the Clinton White House, and the Treasury…. Glass-Steagall was finally euthanized by the Gramm-Leach-Bliley Act… in November 1999…. Glass-Steagall’s death… was the culmination of a decades-long process of financial deregulation in which both commercial banks and shadow banks were permitted to engage in a wider range of activities, while supervision and oversight lagged behind. Competition between commercial banks, investment banks, and shadow banks squeezed the profits of all involved. Many of the affected institutions responded by using more borrowed money and assuming more risk.

The consequences, we now know, were disastrous…. We need comprehensive financial reform to cope with 21st century financial markets. From this point of view, eviscerating the Dodd-Frank Wall Street Reform and Consumer Protection Act, as some in the recently inaugurated Congress propose, would be a step in precisely the wrong direction.