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Law Professor Presents the Facts on Need for Glass-Steagall

Oct. 10, 2017 (EIRNS)—A new research paper by George Washington University law professor Arthur Wilmarth, "The Road to Repeal of Glass-Steagall," presents the hard facts for policymakers as to how that "Road" led to the global financial crash of 2007-08, and should be reversed before another crisis.

Wilmarth is an attorney and teaches banking law and U.S. Constitutional history at GW. He says his article

"sheds further light on that debate [whether eliminating Glass-Steagall caused the crash] by describing Glass-Steagall’s positive impact on the stability of the U.S. financial system from World War II through the 1970s and the adverse consequences of Glass-Steagall’s disappearance."

He presents a detailed chronology of the cancellation of Glass-Steagall regulations, from permitting non-banks to offer uninsured substitutes for checking accounts (money-market mutual funds) in the 1980s, to allowing banks to securitize their commercial loans, to allowing banks to deal in the OTC (over the counter) derivatives markets—ending in permitting American "universal banks" for the first time in 65 years, and full repeal.

Wilmarth then takes on the arguments that these speculations did not lead to the crash. "All three innovations were leading catalysts for the destructive credit bubble that led to the financial crisis of 2007-2009." By "all three," he refers to the non-banks’ uninsured "deposit accounts," the asset-backed securities, and the banks’ broker-dealing OTC derivatives.

The laws which consolidated these regulatory attacks on Glass-Steagall—the Riegel-Neal Act of 1994, Gramm-Leach-Bliley Act of 1999, and Commodity Futures Modernization Act of 2000—

"were highly consequential laws because they (i) allowed large banks to become much bigger and more complex, and to undertake a much wider array of high-risk activities, and (ii) permitted securities firms and insurance companies to offer bank-like products (including deposit substitutes), and (iii) provided a blueprint for light-touch supervision of large financial institutions. All of those factors helped to fuel the destructive credit boom of the early 2000s. I therefore disagree with commentators ... who argue that those laws did not have any significant connection to the financial crisis."

As to the "reforms" which can prevent a repeat crash, Wilmarth concludes,

"At a minimum, those reforms should (i) shrink the shadow banking system by prohibiting nonbanks from offering deposit substitutes, and (ii) establish a regime of strict separation between FDIC-insured banks and the capital markets. The second reform should include a prohibition that bars FDIC-insured banks from entering into derivatives."

Reinstating Glass-Steagal accomplishes those ends.