Monday, December 21, 2009

The Glass-Steagal Myth

William Rees Mogg again repeats the myth that the repeal of Glass-Steagal act (which outlawed companies from being involved in both commercial banking and investment banking) caused the crisis. This is wrong for two reasons:

First, there is no evidence that the few combined commercial- and investment banks (so-called "Universal banks") that were created after the repeal were more heavily involved in the credit boom than others. Indeed, the companies most involved include mortgage companies Fannie Mae and Freddie Mac, insurance company AIG and pure investment banks Bear Stearns, Lehman Brothers and Merrill Lynch, none of whom were affected by the repeal of Glass-Steagall.

Rees-Mogg's only real argument was that if Glass-Steagall had been in place then "It would not have been legal for US commercial banks to buy for their own account the “collateralised debt obligations” or the “credit default swaps”, which led to such large losses".

True, but as the examples I gave illustrates it would have been entirely legal for others to do so. And that would have included the investment banking sections in the few universal banks that existed, only then they would have done it in the independent investment banks that would have existed instead of the investment banking units of the universal banks.

And secondly, and perhaps even more fundamentally, the key cause of the crisis was the monetary policy doctrine of the Fed. Even if we assume for the sake of the argument (and that assumption is for aforementioned reasons not valid) that the repeal of Glass-Steagal did increase credit given a certain monetary policy, the basic doctrine of the Fed was to achieve a certain credit expansion. If other factors had inhibited credit expansion, then the Fed would have lowered interest rates even more and once the zero barrier was reached they would have engaged in various forms of quantitative easing until credit expansion reached the same level as it actually did.

The focus on Glass-Steagal and other forms of regulation is really just a red herring that diverts attention from the key problem of the monetary policy doctrine advocated and implemented by Alan Greenspan and Ben Bernanke. Only monetary reform, not "financial [regulation] reform" can prevent similar problems in the future.