Glass-Steagall vs. Bank Separation: Distinction Is Now Important
April 7, 2017 (EIRNSS)—With bills to restore the Glass-Steagall banking separation act now in both Houses of Congress, and with three Trump Administration representatives having proposed "some version" of it, it will be critical to distinguish what the original Act accomplished, from more recent proposals to "ring-fence" bank holding companies.
The four initiating Senate Glass-Steagall sponsors of S.881 yesterday rightly claimed broad support from American constituencies in both parties, and general support in the Trump Administration including public nods to Glass-Steagall by the President. Treasury Secretary Steven Mnuchin and Council of Economic Advisors head Gary Cohn have both now supported some form of bank separation; and Federal Deposit Insurance Corporation Vice-Chairman Thomas Hoenig has spelled out a tough and detailed version of "ring-fencing" as, essentially, the next best thing to Glass-Steagall. While more House Democrats have signed on to the Kaptur-Jones H.R. 790 to restore Glass-Steagall (there are now 43 sponsors), many House Republicans have privately told EIR representatives they like Hoenig’s plan.
The difference is essentially that between creating a moat to separate big commercial banks from their thousands of securities units, with a bridge with barricades on either end and prominent "do not cross" signs; and allowing no bridge over the moat at all. Hoenig’s plan has strong barricades against deposit banks creating, supporting, or bailing out broker-dealer and derivatives units and vehicles. He proposes explicitly restoring enforcement of Sections 23A and 23B of the Federal Reserve Act of 2013—provisions only inserted into that act in 1933 by passage of Glass-Steagall. If the Wall Street megabank is divided into separately capitalized and managed "major" and "minor" holding companies; and only the major commercial bank holding company has access to Federal insurance; and only AAA-rated assets can move from the speculative units to the major holding company (Sections 23A and 23B); the speculative units appear to be on their own.
But these separations have been created before—including by the biggest banks themselves as they became impossibly complex after Glass-Steagall was destroyed. When the bank crisis exploded over 2007-08, and hundreds of speculative units lost their credit ratings and were failing, the barricades on the bridges were broken down. Those units were bailed out by the main bank holding companies—"taken back on their balance sheets"—and they were still doing it when Bank of America bailed out Merrill-Lynch’s entire $52 trillion derivatives book in 2012 after Merrill was downgraded. The Federal Reserve looked the other way. That mirrored the bank being ordered in 2008 to lose $14 billion buying and bailing out the failing Merrill, and the bank being bailed out in turn by the Treasury.
With Glass-Steagall, in that crisis, there is no bridge, and the commercial bank is prohibited from engaging in the speculative activities of securities units and derivatives traders at all. Those units can and will fail, without exploding the commercial banking system whose business is lending to the economy.