The Housing and Financial Meltdowns Revisited

Five years after the housing and financial meltdown, self-styled
progressives are still peddling their pseudoexplanation: that it
was largely the fault of the 1999 repeal of a provision of the New
Deal–era Glass-Steagall Act, which mandated the separation of
commercial and investment banking. This tale is favored by Sen.
Elizabeth Warren and others of her ilk, who hold the rather absurd
view that the United States had free banking between the 1980s and
the passage of Dodd-Frank in 2010. (See this
 in which Warren attributes the growth of the
American middle class to Glass-Steagall and the middle class’s
decline to the repeal.)

One wonders if Warren et al. ever bother to look at the facts,
particularly the passage of Glass-Steagall and what, if any, role
the repeal actually played in the crisis. Since they never say
anything specific, it’s hard to know if this is anything more than
an incantation designed to blame the “free [sic] market” and to
bolster their case for bureaucratic management of our lives (which
they call “the economy”). It takes Herculean ignorance or
dishonesty to claim that America had free banking before 2010.
Hence, this is a classic confirmation of my observation that no
matter how much the government controls the economic system, any
problem will be blamed on whatever small zone of freedom

According to folklore, Glass-Steagall was passed because of
rampant conflict of interest and abuse among banks that both served
savers and borrowers (commercial banking) and underwrote and sold
securities (investment banking). But this is a case of the victors
writing the history.

In “The
Rise and Fall of Glass-Steagall
” (2010), economists Jeffrey
Rogers Hummel and Warren Gibson explain that Sen. Carter Glass
realized his long-held goal of separating these two banking
functions only after the 1933–34 so-called Pecora hearings in the
U.S. Senate. (Ferdinand Pecora was chief counsel of the Senate
Banking and Currency Committee.) “Revelations of supposed abuses by
National City Bank (NCB) of New York and its president, disclosed
in the Pecora hearings, provided the spark to ignite the issue and
give Glass his victory,” Hummel and Gibson write. But the
revelations revealed nothing terribly substantial against NCB or
its subsidiary, National City Company (NCC).

Among the more serious charges, executives allegedly profited
from the firm’s own securities underwritings. For example, National
City bought a large block of stock in the new Boeing Corporation.
Rather than sell this stock to the public, Pecora charged that NCC
“retained a large block for itself and allotted the remainder to
Mr. Mitchell and a select list of officers, directors, key men, and
special friends.” But an internal NCC memorandum concerning this
stock says,  “[O]n account of the fact this industry is still
somewhat unseasoned, even though we regard this particular company
as sound and having a very bright future, we were not quite ready
to make a general offering to our customers. It would have been
next to impossible to avoid taking orders from the type of investor
who should not buy this stock. Therefore, our own family and
certain officers and employees of the Boeing Co. and affiliations
have taken the entire issue.”

On which Hummel and Gibson comment, “Not only does this not
sound improper, but in fact it sounds like just the sort of prudent
regard for customers’ best interests that was supposed to be
lacking in combined firms such as NCB/NCC.” It certainly was not a
case of a bank peddling dubious securities to gullible

However, they continue,

The committee produced a Mr. Brown, a witness who claimed to
have lost $100,000 as a result of an NCC salesman’s bad advice.
Bankrupt and in ill health, Mr. Brown was an ideally sympathetic
witness, but it turned out that he had been a successful
businessman and not a novice. NCB was forbidden to call rebuttal

Economist George Bentson looked into the complaints against NCB
and Chase Bank in his The Separation of Investment and
Commercial Banking 
(1990) and concluded that they had no
sound basis. Bentson “added a thorough critique of the supposed
theoretical problems of universal banks such as conflicts of
interest,” Hummel and Gibson write, continuing,

But what about conflict of interest? It is certainly possible
that a banker in a combined firm might steer customers into
ill-suited investments or insurance products. This is a hazard we
face whenever we deal with professionals, such as physicians who
advise treatments and also provide them, or lawyers who advise
lawsuits and offer to file them. Such hazards are manageable: We
can always get a second opinion or consult a fee-based financial
planner or simply rely on the professional’s incentive to maintain
a reputation for ethical service.

A few anecdotes and the potential for a conflict of interest
were hardly good reasons for the government to arbitrarily separate
financial functions, depriving customers of the benefits of
integrated services. Hummel and Gibson write,

Financial institutions have widened their offerings considerably
in recent years without any apparent problems. At the website of
Wells Fargo Bank, for example, one finds not only traditional
deposit and savings accounts and loans of all sorts, but also stock
brokerage, mutual funds, automobile insurance, homeowner’s
insurance, and even pet insurance. (But the Wells Fargo branch in a
nearby Safeway store didn’t catch on and was closed.) Similarly,
Charles Schwab, which began as a discount broker, now offers a full
range of investment products and advice as well as banking services
through its affiliated bank. Customers enjoy expanded services and
lower prices as a result of the widening of competition among
traditionally distinct firms. There is no sign of significant or
widespread problems arising from conflicts of interest in such

Hummel and Gibson add that success is not guaranteed for such
companies, and they discuss some notable failed attempts by large
firms to offer assorted financial services.

While the relevant part of Glass-Steagall was repealed in 1999,
Hummel and Gibson point out that it was “becoming a dead letter”
well before then. The repeal mostly codified reality.

“Incidentally,” they write, “no other developed country has ever
seen fit to separate commercial banking from investment banking.
Banks in Germany and Switzerland have always been free to engage in
underwriting and securities holding to no obvious harm.” Aren’t we
often told that Europe is much more enlightened in such