The Bankers Vig And The Price We Pay: The Economic Cost Of Repealing Glass-Steagall

The Glass-Steagall Act of 1933 was enacted to combat over-reaching banking activities that led to financial instabilities and fueled the Great Depression. The act’s primary purpose was to prevent another banking collapse like the one that was crippling banks and leaving depositors penniless at the time.  The legislation’s main thrust was to separate traditional banking activities from trading and investing practices. From 1933 until its repeal in 1999, banks taking deposits were prohibited from trading and underwriting in non-government and non-investment grade securities. The act did not prevent financial crises from occurring, but it certainly prevented a crisis anywhere near the magnitude of the Great Depression. 

In 1999, Congress passed the Gramm-Leach-Bliley Act (also comically known as the Financial Services Modernization Act of 1999) which repealed Glass-Steagall. The repeal, heavily lobbied for by the banking sector, was promoted to the public as a means to unleash bankers’ ability to provide more capital and liquidity to spur economic activity. Less than ten years after the Gramm-Leach-Bliley Act was signed, financial institutions imploded to a degree not seen since the Great Depression. Without the lifeline of massive tax-payer funded bailouts, unprecedented monetary policy, and questionable accounting standards changes, the financial carnage from the crisis of 2008 might have equaled or even surpassed that of the Great Depression. 

The VIG

Many experts warned at the time that the repeal of Glass-Steagall was another instance of greedy bankers looking for a way to pay the bank’s bottom lines and their paychecks with little consideration for the financial stability of their institutions or the potential economic consequences. The bankers won the battle and, as expected, profits in the financial industry soared almost immediately.

The graph below plots quarterly annualized financial corporate profits from 1948 to current. The data is separated by color to highlight the periods before and after the repeal of Glass-Steagall. Additionally, the red dotted regression trend line, showing trend profit growth pre-repeal, serves as a useful gauge to estimate the financial benefit to the banks of repealing Glass-Steagall.

Data Courtesy: St. Louis Federal Reserve (FRED) (NIPA profits with IVA and CC adjustments, Domestic – BEA)

As seen by the gap higher in profits in 1999, and how profits reset to an approximate 50% premium to the pre-1999 trend line, the repeal of Glass-Steagall was a windfall to the financial industry.

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