Elizabeth Warren introduced a bill today to split nice old-timey banking (taking deposits, making loans to people and corporates) from investment banking and other assorted eeeeevil activities (trading, derivatives, etc.) and it comes with a poster. It also comes with a throwback name, “The 21st Century Glass-Steagall Act of 2013,” after the guys who last split commercial and investment banking from 1933 until their Act’s repeal in 1999ish. Some people are calling the new proposal the Warren-McCain bill, because John McCain is a co-sponsor of this/every bill. I will compromise and refer to it as “The Warren-McCain 21st Century Glass-Steagall Act of 1933 of 2013.”

That’s roughly all I have to say about it? It probably won’t happen, and the goal of keeping depositors safe by limiting depository institutions to boring regular banking is mostly a silly one.1 Mortgages! Mooooooooooooooooortgages! The boring, take-deposits-and-make-real-estate-loans banks in Spain and Ireland and Cyprus and Bedford Falls and 1989 managed to blow themselves up just fine without any help from investment banking.

But you knew all that, gah. This bill is not really about depositor safety in any sort of empirical way. It’s a more ancient and anthropological theory of the dangers posed by banking: there are pure activities and impure activities, and the danger comes from mingling the pure and the impure. You build two buckets and you keep them apart, not because one bucket is riskier than the other but because things just belong in their own buckets:

It’s utterly unsurprising that the bill is particularly focused on derivatives, perhaps today’s most impure corner of the financial world. E.g.:

A national banking association shall not invest in a structured or synthetic product, a financial instrument in which a return is calculated based on the value of, or by reference to the performance of, a security, commodity, swap, other asset, or an entity, or any index or basket composed of securities, commodities, swaps, other assets, or entities, other than customarily determined interest rates, or otherwise engage in the business of receiving deposits or extending credit for transactions involving structured or synthetic products.2

But many of the main flavors of derivatives, from an economic importance perspective, grew out of traditional banking. Evil credit default swaps were invented by JPMorgan in the Glass-Steagall era, when it was a commercial bank and wanted to hedge its commercial loan book. Interest-rate swaps also have a mostly traditional-banking history, starting as a way to let banks and borrowers hedge the interest rate risks of their loans. These were not risky investment-banking activities that mingled uneasily with good old-fashioned safe banking. They were attempts to make old-fashioned banking safer.3

Now, though, they’re viewed as an evil function of investment banking, which is probably more or less because Glass-Steagall was repealed and big swap-dealing banks could also be everything-else-dealing investment banks. And, if the new Glass-Steagall un-repealers get their way, commercial banks will be separated from all of their dealings, including the ones they came up with under the old Glass-Steagall.

Which isn’t really good or bad I guess. But the financial world is interconnected and path dependent; complexity has arisen over time because it responds to actual needs. Just wanting finance to be simpler won’t make it so, and legislating that a portion of the financial system become simple on its own seems like a risky proposition.

Senators Warren, McCain, Cantwell, and King Introduce 21st Century Glass-Steagall Act [Senate.gov]
21st Century Glass-Steagall Act of 2013 [Senate.gov]
Lawmakers Move to Rebuild Wall Between Commercial and Investment Banking [WSJ]

1. Obviously I’m biased, since my job is basically finding banking interesting. And my previous job was basically making it that way.

2. Is paying the guarantee fee for a Fannie/Freddie mortgage guarantee a structured transaction? Is a GSE RMBS a structured transaction? Worth pondering.

3. Oh, I kid, the CDS thing was mostly about avoiding capital requirements. But. Hedging!

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Comments (20)

  1. Posted by Guest | July 11, 2013 at 8:13 PM

    I think we should separate high risk activities like being in the Senate from low risk activities like being a professor.

  2. Posted by LevineCampaignQuant | July 11, 2013 at 8:46 PM

    Vote for Matt Levine for Senate! Make banking even more interesting, and, meh, I had something here, uhm, charts, obvs.

  3. Posted by Not UBS | July 12, 2013 at 8:25 AM

    Any legitimate reasons to not support this bill, which might conceivably decrease financialization and so on?

    This is sub-par for you Matt. Would love to see an in-depth analysis.


  4. Posted by morephonyjournalists | July 12, 2013 at 8:56 AM

    Shill for the banks, much?

  5. Posted by YouWork@UBS? | July 12, 2013 at 9:16 AM

    Too dumb to realize you're on a financial blog, much?

  6. Posted by Guest | July 12, 2013 at 9:42 AM

    I agree. Matt spent 648 words (I counted) not mentioning the entire motivation for separation of the "pure" from the "impure": that there is a lot of political will for the Federal government backstopping the former, and virtually no political will for backstopping the latter. That is especially important when it is the latter, particularly the derivatives, that produce the massive open-ended losses that characterized the previous financial meltdown – and when banks that used to be in the "impure" business that ran out and bought "pure" banks to assure that Federal support would be forthcoming.

    The whole idea of this bill would not be to prevent bank failures, which are as old as, well, banking, but to prevent the Federal government from being forced to write blank checks to bail out massive financial institutions due to failures having little to do with traditional loans and a lot to do with speculation.

  7. Posted by dogman | July 12, 2013 at 9:48 AM

    matt, would you recommend fool's gold?

  8. Posted by Guesteban | July 12, 2013 at 10:27 AM

    "complexity has arisen over time because it responds to the actual need to generate fees"

    There, fixed it for your.

  9. Posted by Too dumb | July 12, 2013 at 10:46 AM

    Too dumb to realize financial blog is not necessarily coterminous with bank shiller?

  10. Posted by dogman | July 12, 2013 at 10:50 AM


    Should save you some time in the future. (Good comment btw.)

  11. Posted by Not UBS | July 12, 2013 at 1:43 PM

    Precisely my point. Also, consider this as a hypothetical:

    1. Pure activities get federal backstopping AND commensurate regulation to make sure they don't go crazy.

    2. Impure activities get put into ibanks which are then forced to ONLY be private partnerships since corporate governance is a joke when your shareholders don't know leverage from a crowbar. Regulation gets severely reduced to only criminal activities (i.e. fraud, etc.) Also, the leverage ratios and risk would probably decrease significantly if the long-run profit/loss was forced to be a risk on the personal $ of the ibanks' executives.

    Wouldn't that be far more efficient and stable of a system than the current system? Can't Glass-Steagall be part of a good move to financial reform.

  12. Posted by Gimme, gimme, gimme | July 12, 2013 at 4:43 PM

    for your what? C'mon, man, don't do this to me! I'm sitting on the edge waiting for the punchline!

  13. Posted by Count Ziggenpuss | July 12, 2013 at 4:51 PM

    "Evil credit default swaps were invented by JPMorgan in the Glass-Steagall era, when it was a commercial bank and wanted to hedge its commercial loan book. Interest-rate swaps also have a mostly traditional-banking history, starting as a way to let banks and borrowers hedge the interest rate risks of their loans." YOU KNOW ANOTHER BRILLIANT WAY TO "HEDGE" YOUR LOAN BOOKS??? HAVE MORE CAPITAL AVAILABLE TO ABSORB POTENTIAL LOSSES – IE, LESS LEVERAGE… THEN YOU DON'T NEED THOSE CDS AND IRS, DO YOU?

  14. Posted by LCB | July 12, 2013 at 5:34 PM

    The 21st Century Glass-Steagall is mostly an anthropological study in how far certain politicians will go and hiw many dead hirses they will flog to get their names in the headlines.

  15. Posted by John Thain | July 14, 2013 at 1:34 PM

    BOA and Merrill split? YAY maybe I can get my job back

  16. Posted by guasto | July 15, 2013 at 6:07 PM

    yeah, that would be awesome. i mean, wouldn't actually "hedge" anything, but fk it, you're on a roll, i won't stop ya. but wait… oh, oh, even better! just stop making loans in the first place! no loans, no loan exposure. QED. you don't have to be john pierpont fking morgan to understand this stuff, people. hell, pay back the deposits too, there's always a chance the damn townspeople will show up at your door with pitchforks and demand their money back anyway. what else can we do to clean up around here?

  17. Posted by Count Ziggenpuss | July 17, 2013 at 11:28 AM

    Totally!!! Because the goal of a "hedge" is to reduce the risk of losses due to adverse price movements in an asset… which is completely at odds with higher capital requirements, which are designed to ensure that banks have enough capital to… er… um… sustain losses (ya, know… while maintaining a safe and efficient market). But, as you say… fk it. Let's not regulate banks at all. In fact, get rid of them entirely… since they clearly cannot independently determine who is credit worthy and who is not. What is their role, if not to exercise expert judgment? We can just leave piles of money around and ask borrowers to self-regulate their appropriate credit limits.

  18. Posted by Count Ziggenpuss | July 17, 2013 at 11:53 AM

    And fyi… it's best to use "QED" when you actually win the argument. Otherwise, you're just a dousche-bag. Something tells me you dress like this… http://www.ralphlauren.com/shop/index.jsp?categor

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