Bapcha’s Stocks.

My take on the banking crisis – if Glass-Steagall was the law today.

Posted on August 28th, 2008 in Blythe Masters, Glass-Steagall, Gramm-Leach-Bliley Blythe Masters, Glass-Steagall, Gramm-Leach-Bliley

Many prominent economists [mostly the ones who want to be considered for political appointments] have gone on record in recent weeks – saying that if Glass-Steagall was law today, the banking crisis would never have occurred. Glass-Steagall [G-S] a.k.a The Banking Act of 1935 [passed in 1933] was the law that created the FDIC and separated investment banking from commercial banking in an attempt to curb speculation which led to the crash of 1929. I disagree. It was the good ol’ forces of greed and fear that led to the current banking crisis. Mostly greed.

Parts of Glass-Steagall were repealed by the Gramm-Leach-Bliley Act of 1999 [GLBA] – making it OK for investment banking and commercial banking to merge, underwrite, own insurance arms, etc. GLBA did not repeal the existence of the FDIC.

The first Collateralized Debt Obligation was underwritten by Drexel-Burnham Lambert back in 1987 – when GS was still the law. LTCM famously had equity in excess of $4 billion, but off-balance sheet derivative positions in interest rate swaps of $1.25 Trillion [they got into serious trouble in 1998, and closed in 2000].

CDS’s have grown exponentially in the last decade and what they do is separate the risk of whatever [interest rate going up or down, or the bond getting called or defaulting thereof] from the instrument. If you want to read about CDS’s, here is a primer – co-authored by Blythe Masters.

Bottom-line:

1. I started writing an article on why everything would be fine and dandy if G-S was still law. I quickly realized that it would be too simplistic.

2. Then I read the primer by the bloody brilliant brit Blythe [most of which I knew].

3. My final conclusion is that banks that fail – must be allowed to fail [much like people are].