Tag Archives: Glass Steagall Act

03.26.2013 | Deposit Insurance: The Importance of Confidence

Cyprus’s banking crisis made me think of the FDIC sign in my local bank. Located right where I can see it, the reminder inspires confidence. Similarly, on an FDIC web site, they say at the top, ”Since the FDIC’s creation in 1933, no depositor has ever lost even one penny of FDIC-insured deposits.”

By contrast, before the FDIC was created in 1933, most depositors lacked the confidence that their savings were safe. As a result, just a rumor that a bank was troubled could create a run. And, requiring more money than the bank could provide, that run could make the bank fail.

Then came Glass Steagall with its deposit insurance provision. Since then, the number of bank failures caused by small depositor runs has dwindled to almost nothing. We know that the federal government will give us our money when the bank can’t.

I wonder, though, how much Cyprus has changed European attitudes about deposit insurance. Yes, monetary authorities decided that their initial proposal was a bad idea and will not ask insured depositors to pay a 6.75% “tax.” But still, haven’t they eroded the confidence that is the bedrock of deposit insurance?

A little history…

One of the first banking insurance funds was established by New York State in 1829 after a banking crisis. Supporters of the idea emphasized that depositor insurance made banks safer. Opponents worried that healthy banks paid for the excesses of weaker ones and “public scrutiny” would diminish.

While today, we continue to debate the same issues, all agree that confidence is necessary. And that returns us to Cyprus and a short-lived proposal that might have a long term effect.

Sources and Resources: Roger Lowenstein’s NY Times column offered considerable insight and history on deposit insurance. Complementing his insight, this FDIC site provides more practical facts about deposit insurance ($250,000 for a single account in one person’s name) and here, at econlife we have more on Glass Steagall.

Posted by: adminEcon
Tags: banking confidence, Cyprus, deposit insurance, FDIC, Glass Steagall Act
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07.18.2010 | Figuring Out Financial Regulation

Words cannot describe the 2300 pages of the Dodd-Frank Wall Street Reform and Consumer Protection Act. In a way, because it says so much, it tells us very little. Still though, after looking at the bill and several news summaries, I wanted to share some main ideas.

At first, “risk” and “protection” were the two words that came to mind. Risk: Lawmakers want to manage the impact of the risks taken by financial institutions. Protection: Lawmakers hope to protect consumers from making unwise financial decisions.

Then, I discovered a second approach that made sense to me at WSJ.com where they described the basics of the bill through four categories:

1) Government: Its powers will grow in order to preserve financial stability. Starting with the Federal Reserve, countless government regulatory agencies will be transformed.

2) Banks: Financial firms will experience new restrictions on trading different types of complex securities.

3) Consumers: A new bureau to protect consumers will be established. Its responsibilities will impact a plethora of financial activities.

4) Investors: Different investing groups such as hedge funds, people who give investment advice, insurance companies, and those who create securities packages will have new constraints.

Essentially then we have four groups responding to a Congress that hopes to control financial risk and expand financial protection. With 2300 pages of text, mathematically, the ways in which the four groups can respond and then interact create countless permutations.

The Economic Lesson

Passed in 1932 and 1933, the Glass-Steagall Act separated investment and commercial banking, changed the structure of the Federal Reserve, and created the FDIC. Although it was formally repealed in 1999, regulators permitted financial institutions to violate its spirit beforehand. When I read the act, I was surprised to see language that was as tough to follow as the current financial reform bill. However, as 34 pages of legislation, it had fewer variables and appeared to cover many of the necessary regulatory details.

Posted by: adminEcon
Tags: Dodd-Frank Wall Street Reform and Consumer Protection Act, financial reform, Glass Steagall Act, government regulation
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06.02.2010 | BP and the Financial Crisis

I suspect that there is an inverse relationship between government’s ability to get regulation right and the length of the legislation. Glass-Steagall was 34 pages long. Recently proposed financial legislation is 3000 pages long.

The need for appropriate regulation is where Harvard professor Richard Rogoff is heading when he compares the BP oil spill and the financial crisis. Both, he says were characterized by “the promise of innovation, unfathomable complexity, and lack of transparency.” Both also are connected to economic growth, economic catastrophe and the need for a global regulatory consensus. Quesioning whether a global financial consensus is feasible, IMF officials have said that individual nations are acting but the pieces don’t fit together. For offshore drilling, we can say the same when we consider the disparate incentives facing Brazil, the United States, and Nigeria.

Professor Rogoff concludes his paper with, “This time we can ill afford to keep getting it wrong.” I wonder though, whether, faced with the allure of innovation and the challenge of such complexity, government can ever get it right.

The Economic Lesson

I recommend looking at: This Time Is Different by Richard Rogoff and Manics, Panics, and Crashes, A History of Financial Crises by Charles Kindleberger. Both present the facts. By looking at the past, you can best decide what is wisest for future regulatory policy.

Posted by: adminEcon
Tags: financial regulation, Glass Steagall Act, oil spill
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03.04.2010 | The Banking Pendulum

As George Bailey in “It’s a Wonderful Life,” Jimmy Stewart faces a bank run. On his wedding day, hoping to save his bank, George first gives out the bank’s cash and then his honeymoon money to a long, agitated line of panicked depositors.

During the bank run, in two sentences, George Bailey summarizes the basics of banking. “You’re thinking of this place all wrong, as if I had the money back in a safe. The money’s not here. Your money’s in Joe’s house … and a hundred others,” George Bailey is referring to a fractional reserve system in which banks keep part (a fraction) of a deposit in reserve and then loan and invest the balance.

Through loans and investments, just as the heart pumps nutrients around the body, banks and other financial institutions pump money around the economy. And, just like we need a healthy heart, we need healthy financial institutions for economic growth. How to maintain healthy financial institutions is a question our Congress has repeatedly had to ask.

I keep thinking of a pendulum swinging back and forth between more and less government regulation. During the 1930s, government regulation increased. In 1980, regulation diminished somewhat as banks needed more freedom to compete in a changing financial environment. In 1999, with the repeal of the Glass-Steagall Act, the pendulum continued its swing toward less government.

Now, where should it go?

The Economic Life

Between the Civil War and the First World War, we had banking panics in 1873, 1884, 1890, 1893, 1896, 1907, and 1914. “It’s a Wonderful Life” looked at the banking panic of the early 1930s. Many banking crises led to reform legislation. Initially celebrated, the reforms eventually failed.

Posted by: adminEcon
Tags: "It's a Wonderful Life", banking panics, financial crisis of 2007, Glass Steagall Act
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