Must-Read: Megan McArdle: Why Democrats Fixate on Glass-Steagall

Must-Read: The reason to repeal the repeal of Glass-Steagall is that (1) it has not led to increased competition and lower fees in investment banking, and (2) it creates a point of vulnerability at which financiers can make bets with the government’s money. narrow-banking advocate Milton Friedman was especially shrill on this point: that deposit insurance was necessary, but that banks with government-insured deposits should be restricted to buying Treasuries and only Treasuries:

Megan McArdle: Why Democrats Fixate on Glass-Steagall: “Team Steagles… seem[s] to have become a powerful force in the Democratic Party…

…The provisions limiting the entrance of commercial banks into investment activities (and vice versa) were gradually relaxed, and then abolished with Gramm-Leach-Bliley (the Financial Services Modernization Act of 1999). Calls to ‘bring back Glass-Steagall’ are, in fact, almost always calls to bring back this one provision…. It would be an amusing and depressing exercise to get any of these candidates in a room with some economists and ask them to explain how Glass-Steagall could have prevented the 2008 crisis. For there is a small problem with the Steagles argument: It’s very hard to think of the mechanism by which the repeal of this rule made any significant contribution to the meltdown….

This is why you don’t hear a lot of experts calling for the return of this rule. Those who do want it reinstated don’t claim that it would have prevented the financial crisis. For example, I quote Raj Date and Mike Konczal of the left-wing Roosevelt Institute, from their paper ‘Out of the Shadows: Creating a 21st Century Glass Steagall’: ‘The loosening of Glass-Steagall prohibitions did not directly lead to the financial crisis of the past few years.’ Why, then, do so many people want it back?  Fighting ‘Too Big to Fail.’… Moral hazard/protecting the taxpayer…. Exotic political economy arguments… [that] are hard to prove or disprove….

Glass-Steagall… is the perfect Washington Issue: a proposal of negligible impact but great popular charm. It is a way for politicians to sound as if they are addressing some major problem without having to go to the trouble of actually doing so. Glass-Steagall’s major appeal is not that it would work, but that it can be explained in under a minute to someone who doesn’t know anything about financial markets…

November 19, 2015


Brad DeLong
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