The Free-Market Republican’s Case for Glass-Steagall

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It might seem difficult to make a conservative argument for the Depression-era Glass-Steagall Act, which required a firewall between federally insured banks’ investments and consumer banking arms. But some proponents are trying, and the inclusion of an endorsement of the law’s return in this year’s Republican Party platform has strengthened their case.

In a series of interviews, right-leaning economists outlined for Morning Consult the rationale for considering some modern version of Glass-Steagall, although their views don’t represent the entirety of the Republican Party.

Even so, this year’s presidential campaign has been full of surprises for the economic establishment in Washington and New York. The now-dormant Glass-Steagall law was already known as a key issue for progressive lawmakers such as Sens. Elizabeth Warren (D-Mass.) and Bernie Sanders (I-Vt.), but it was a new development to see it creep up among Republicans.

In perhaps the most unexpected area of convergence between Republican and Democratic platforms this year, both parties’ campaign platforms endorse reinstating some form of the law.

The leftist case for reinstating Glass-Steagall portrays the banking world since the law’s 1999 repeal as a house of cards built on high-risk gambling with consumer funds. The current legal landscape comes with the moral hazard of a possible bailout on the backs of taxpayers, liberals argue. They also blame the 2008 financial crisis, in part, on the repeal of Glass-Steagall.

A similar but distinct argument carries water on the right. Despite suggestions otherwise, the embrace of Glass-Steagall by the Republican Party in the 2016 platform is not an anomalous event connected to Donald Trump’s unusual nomination. Some Republican lawmakers — most notably 2008 presidential nominee Sen. John McCain of Arizona — are longtime advocates for some version of the law and argue on conservative grounds for its reinstatement.

According to that argument, the removal of Glass-Steagall did not contribute to the 2008 financial crisis. However, bringing back the law, conservative advocates argue, would achieve a number of free-market focused outcomes that Republicans embrace.

First, a reinstatement would address a structural problem in current law in which, as the saying goes, the banks’ profits are privatized but their losses are socialized. Because of federal deposit insurance, which came as part of the New Deal package that also led to Glass-Steagall, large banks with securities trading arms are protected from any major losses they take because of the Federal Deposit Insurance Corp.

Of course, eliminating the FDIC could also solve this problem and possibly satisfy free-market advocates. But given its political peril, that simple change would almost certainly be a nonstarter in the policymaking mainstream. Another “simple” fix on the left, which would likely be similarly unpopular, would involve nationalizing the banks to ensure the government receives a cut of the earnings.

For those reasons, Glass-Steagall provides an effective, if partial, way to restructure the riskiest elements of the banking system. Even though the law’s status as a vestige of liberal New Deal regulation might give some conservatives pause, eliminating the de facto federal subsidy for risky bank behavior is still a better outcome from a free market perspective, said Saule Omarova, who was a special adviser for domestic regulatory policy at the Treasury Department from 2006 to 2007.

“Because it doesn’t socialize the profits, the free-market supporters are kind of uneasily willing to live with [Glass-Steagall],” said Omarova, who’s now a professor at the Cornell University School of Law. “It’s difficult. It’s not the easiest solution. It’s just the more fundamental solution.”

Free-market Republicans also argue that financial reforms like the Dodd-Frank Act of 2010 have choked competition, and that their deregulatory agenda could encourage more competition among banks. The free-market Glass-Steagall supporters generally agree on deregulation, but they also think that a Glass-Steagall-like firewall between investment and commercial banking could place smaller broker-dealers and community banks on better footing with the big hitters on Wall Street.

The financial deregulation that began in the 1980s and culminated when former President Clinton signed the Glass-Steagall repeal in 1999 helped the large banks consolidate their assets and influence in Washington, according to the conservative argument. As a result, Omarova said, competition in the market has been distorted because large banks that can support trading arms, combined with their access to an effective federal subsidy, can run circles around both community banks and small broker-dealers.

“It’s so funny that all of the free-market advocates against Glass-Steagall say, ‘Well, we like competition, but we don’t want Glass-Steagall reinstated,’” Omarova said. “If Glass-Steagall is reinstated, then sectors compete against each other. Isn’t that a better world?”

In Washington, large banks in effect speak with one voice because their regulatory interests have converged, according to Luigi Zingales, a finance professor at the University of Chicago.

“The fragmentation that was present before the removal of Glass-Steagall allowed for a more balanced set of opinions on Capitol Hill, which made the system work better,” said Zingales, a free-market economist whose work has been cited in Republican circles.

Omarova and Zingales are not the only experts with Republican credentials who favor reinstating Glass-Steagall. Tom Hoenig, the FDIC’s vice chairman and a frequently cited economist in GOP policy circles, argued along similar lines in a 2012 white paper. Hoenig said the over-complication of the financial sector that has arisen because of the link between investment banking and consumer activity proves the need for Glass-Steagall’s resurrection.

“The root of the problem is that large, complex financial institutions are funding long-term, illiquid assets with liabilities available upon demand,” Hoenig wrote in 2012. “The industry is dominated by a handful of companies that combined are half as large as annual U.S. economic output, and the failure of any of them could cause financial instability.”

However, the support from Trump, Hoenig, McCain, Omarova, and Zingales should not be viewed as representative of the conservative establishment. House Financial Services Committee Chairman Jeb Hensarling (R-Texas) said in a statement immediately after the inclusion of the platform language that his focus is on deregulation through his Dodd-Frank replacement, the Financial CHOICE Act.

Alex Pollock, an economist with the free-market R Street Institute, also dismissed the arguments favoring Glass-Steagall. “I see no reason for it,” he said. “It didn’t achieve what it was meant to do in the beginning. It basically protected investment banks from competition and gave them a nice little cartel for 50 years.”

Advocates who “want to resurrect Glass-Steagall back from the dead fail to understand where the risk really is,” Pollock added.

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