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!