2011-10-15 The Economics of Occupy Wall Street, Part I: The Glass-Steagall Act

"I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs." -- attributed to Thomas Jefferson

So far lacking a central spokesperson, the Occupy Wall Street (OWS) movement has not always clearly articulated specifics of its demand for justice through economic reform; even many who support the demonstrations seem unclear as to exactly what the protesters want, and insiders have reported that the demonstrators have yet to arrive on a consensus regarding their platform. Interviews and research, however, reveal a few specific proposals for economic reform that have been suggested among OWS protesters, including: re-instating the Glass-Steagall Act, overturning the Supreme Court's decision in Citizens United, and organizing an Article V Convention to pass amendments to the U.S. Constitution. This post focuses on the Glass-Steagall Act, regulatory legislation that was passed after the 1929 stock market crash and repealed by President Clinton. Many economists identify this repeal and other Clinton-era deregulation measures as the main causes of the current global economic crisis.

Following the 1929 crash that led to the Great Depression, more than 5,000 banks failed, and roughly US$ 7 billion of depositors' money was erased; millions of U.S. citizens lost their homes and life savings. Many blame the crash on stock market speculation by the banks, which were said to have taken too much risk with depositors' money. Allegations of rampant corruption, stock market manipulation, bad loans, and conflicts of interest surfaced. In 1933, congressmen Carter Glass and Henry Steagall introduced the Glass-Steagall Act, a bank-rescue measure that aimed to minimize conflicts of interest and risky speculation by creating a wall between commercial and investment banking: banks had to choose either one activity or the other, and commercial banks could derive only a small percentage of their revenue from securities.

Throughout the past generation, however, the financial sector succeeded in slowly eroding Glass-Steagall's restrictions. Gradually, the banks largely won back the ability to engage in various forms of market speculation. Meanwhile, Congress made 12 separate attempts to repeal Glass-Steagall. Former Federal Reserve Chairman Paul Volcker expressed concern that lenders would market bad loans to consumers, in order to win bigger earnings on securities. But in 1987 Alan Greenspan (former J.P. Morgan director) replaced Volcker at the Fed, and supported further deregulation. By 1997, the Fed had eliminated many of Glass-Steagall's restrictions, and permitted banks to acquire securities corporations.

The following year, Sandy Weill and John Reed announced the largest corporate merger in history, a US$ 70 billion deal that combined Travelers Insurance (owner of Salomon Smith Barney investment firm) and Citicorp (Citibank's parent company), to create Citigroup Inc., the world's largest financial services corporation. But since the deal directly violated Glass-Steagall, Weill and Reed launched a massive lobbying campaign to repeal that legislation, pass a new bill (the 1999 Financial Services Modernization Act), and make their mega-corporation legal. This effort has been called "the best-financed campaign of influence-buying ever seen in Washington." Reports indicate that, in 1997-1998, the banking, insurance, and brokerage industries spent over US$ 300 million on the lobbying campaign, which included political campaign donations, political party contributions, and lobbying of elected officials. The massive expenditures paid off in 1999, when President Clinton signed the new bill into law. This major deregulation legislation removed almost all restraints on financial-system monopolies, permitting the integration of banking, insurance, and stock market speculation. For good measure, Congress also passed the Gramm-Leach-Bliley Act, which further destroyed the walls Glass-Steagall had erected between commercial and investment banking.

The year before the Citigroup coup, "Weill had called [U.S. Treasury] Secretary Rubin to give him advance notice of the upcoming merger announcement. When Weill told Rubin he had some important news, the secretary reportedly quipped, 'You're buying the government?'" Later, shortly before the Glass-Steagall repeal, Rubin accepted a job as Weill's top lieutenant at Citigroup.

At the time of the repeal, Kenneth Guenther of Independent Community Bankers of America, stated, "This is going to begin a wave of major mergers and acquisitions in the financial-services industry. We're moving to an oligopolistic situation." Others noted that the incestuous relationship between banking, insurance, and the stock market created a situation in which a significant stock market plunge would severely damage both the U.S. financial system and consumer credit. Senator Paul Wellstone cautioned that Congress was "about to repeal the economic stabilizer without putting any comparable safeguard in its place." Jeffrey Garten, Clinton's former Undersecretary of Commerce for International Trade, agreed that the failure of any of these new mega-corporations "could take down the entire global financial system."

Many economists now see the Clinton-era deregulations as the major cause of the recent credit market crisis and severe recession. As banks ventured into selling stock and insurance, oversight was minimal, and risky speculation was great. Banks increased both their lending and borrowing to buy securities (including subprime mortgages) for their own benefit, and that market crashed in 2008. Some counter that Glass-Steagall’s repeal is not to blame for the current financial crisis, and that a financial disaster would have occurred even with Glass-Steagall still in place. They point to the existence of a "shadow banking" system beyond the reach of Glass-Steagall, and to lending institutions' questionable banking practices. Others blame the greed and overreaching of Wall Street itself. Former congressman Jim Leach asserts that the problem lies not with the creation of major conglomerates, but rather with “the greatest regulatory breakdown in history, on the part of the Fed, the Treasury and the Securities and Exchange Commission.”

There may be multiple factors in the economy's collapse. A report by Essential Information and the Consumer Education Foundation indicates that the financial sector spent US$ 3.4 billion on lobbyists and made almost US$ 2 billion in political contributions from 1998-2008. This influence-buying purportedly resulted in at least a dozen deregulatory decisions (including the repealing of the Glass-Steagall Act) that cumulatively caused the crash. The report also describes a symbiotic relationship between Wall Street and Washington. Finance-sector veterans like Rubin and Henry Paulson gained top government regulatory posts, and a number of the finance industry's 3,000 lobbyists had served in top-level positions in Congress and the executive branch. As a presidential candidate, Barack Obama criticized the rampant lobbying and resulting deregulation. Since then, however, former Securities and Exchange Commission (SEC) chairman Arthur Levitt Jr. has countered, "I think they've [the Obama team] said the right things, but they've left it entirely up to a Congress which is seduced by lobbying pressures." Some note that Wall Street seems to have learned little from the lessons of the recent economic collapse, and that risky speculation and large bonuses are again on the rise.

A few politicians are attempting to re-regulate the conglomerates and avert further economic disaster. Senator John McCain has taken steps to try to reinstate Glass-Steagall. Former Fed chair Volcker introduced a proposal dubbed the "Volcker rule" -- which some have described as "Glass-Steagall Lite" -- that would prohibit some banks from risky speculation. Volcker wants to break up the financial conglomerates and reinstate the wall that had previously separated commercial and investment banking. But noted economist Nouriel Roubini avers that neither the Volcker proposal nor the Obama administration's financial reform legislation goes far enough to rein in the mega-banks: "If they're too big to fail, they're just too big, and they should be broken up. If they're too big to fail, they're also becoming too big to be saved, too big to be bailed out, and too big to be managed. No CEO can monitor the activities of thousands of separate profit and loss statements, and the activities of thousands of different bankers and traders." Also pointing to conflicts of interest inherent in large financial "one-stop-shops," Roubini favors reinstating Glass-Steagall. The SEC has yet to vote on the Volcker rule. (Public comments on the measure will be accepted until January 13.)