Elizabeth Warren: Glass-Steagall Initiative With McCain a Good Thing?

The progressive icon whose rocketing political career has been fueled by her unyielding ambition to reform Wall Street has teamed up with the Republican Party’s 2008 presidential nominee to do just that.

Senators Elizabeth Warren (D-Mass.) and John McCain (R-Ariz.), along with Maria Cantwell (D-Wash.) and Angus King (I-Maine) are proposing the “21st Century Glass Steagall Act”, which would essentially rebuild the firewall between investment banking and commercial banking outlined in Sections 20 and 32 of the Depression-era Banking Act of 1933. It aims to separate traditional commercial banks that offer checking and savings accounts insured by the FDIC from “riskier financial institutions” in the realm of investment banking, insurance, swaps dealing, hedge funds and private equity.

Those sections were repealed in 1999 by the Gramm-Leach-Biley Act (GLBA). The argument at the time for repealing those key sections of Glass-Steagall was that the financial industry had changed in the past half-century and that to remain at the top going into the 21st Century, American financial institutions shouldn’t be tied down by regulations that made sense in the 1930s but maybe not so much today. Glass-Steagall was also effectively paralyzed by the time it was formally repealed thanks to the successful efforts of Wall Street’s lobbying and Washington’s eased enforcement and interpretation of the law in the previous two decades.

But then came the financial crises not a decade later, and many point to the repeal of Glass-Steagall as the act that opened the floodgates for consolidation of banks that made them too big to fail and too big to manage. And when the largest 0.2% of banks controls almost 70% of bank assets, there’s definitely some truth to that. If a small bank goes under, the damage is fairly localized. If a megabank fails, the entire economy plummets into a state of shock, only to be bailed out by the taxpayer. Proponents of Glass-Steagall’s re-institution say that when you have the historically safe, federally insured commercial banking industry breeding with riskier investment banking, you’re effectively spreading the risk associated with investment banking to commercial banking — a place it has no business being. After all, you wouldn’t want anyone taking risky bets with your savings account or retirement.

McCain cites his support for reinstating Glass-Steagall as wanting to protect taxpayers and restore confidence in the financial markets, even going so far to suggest in a statement that the partial repeal of Glass-Steagall has enabled and encouraged a culture of dangerous greed and excessive risk-taking in the banking world.

Glass-Steagall’s restoration has even won the endorsement of Wall Street veterans who took an active role in ushering in the era of bank conglomeration. Sanford “Sandy” Weill, the former chief executive and chairman of Citigroup, has said that gutting Glass-Steagall was a mistake. Weill was instrumental in engineering the 1998 merger of Travelers Group Inc. with Citicorp, a merger that convinced Congress that Glass-Steagall was effectively obsolete and needed repeal. Richard Parsons, who served on Citigroup’s board for 16 years, said in April that Glass-Steagall’s repeal made the business more complicated and contributed to the financial crisis.

While it is accurate to suggest that the gutting of Glass-Steagall contributed to the financial crisis, and that reinstating it could bring more stability and security to the financial sector, it is inaccurate to suggest that its repeal was the main cause of the financial crisis.

Bear Stearns, Lehman Brothers and Merrill Lynch — the three institutions at the heart of Wall Street’s collapse — were investment banks that had never actually crossed the line into commercial banking. Ditto for Goldman Sachs. AIG is an insurance firm and New Century Financial was a real estate investment trust, neither of which have anything to do with Glass-Steagall. Wachovia and Washington Mutual, two of the biggest banks that went under, failed largely by making risky loans to homeowners. Bank of America’s troubles did not derive from them buying an investment bank but rather because they bought Countrywide Financial, a vanilla-variety mortgage lender.

Restoring Glass-Steagall has been a rallying cry that has united everyone from some in the Tea Party to Occupy Wall Street protesters. But just because common ground is found on this does not necessarily make it the best option.

Personally, I like Senator Sherrod Brown (D-Ohio) and David Vitter's (R-La.) bill that would impose a 15% capital requirement on the largest banks.