Why Zingales Now Endorses Glass-Steagall

Luigi Zingales has changed his mind about Glass-Steagall:

Why I was won over by Glass-Steagall, by Luigi Zingales, Commentary, FT: I have to admit that I was not a big fan of the forced separation between investment banking and commercial banking along the lines of the Glass-Steagall Act in the US. I do not like restrictions to contractual freedom, unless I see a compelling argument that the free market gets it wrong. Nor did I buy the argument that the removal of Glass-Steagall contributed to the 2008 financial crisis. The banks that were at the forefront of the crisis – Bear Stearns, Lehman Brothers, Washington Mutual, Countrywide – were either pure investment banks or pure commercial banks. The ability to merge the two types was crucial in mounting swift rescues to stabilize the system – such as the acquisition of Bear Stearns by JP Morgan and of Merrill Lynch by Bank of America.

Over the last couple of years, however, I have revised my views and I have become convinced of the case for a mandatory separation.

There are certainly better ways to deal with excessive risk-taking behavior by banks, but we must not allow the perfect to become the enemy of the good. In the absence of these better mechanisms, it makes perfect economic sense to restrict commercial banks’ investments in very risky activities, because their deposits are insured. Short of removing that insurance – and I doubt commercial banks are ready for that – restricting the set of activities they undertake is the simplest way to cope with the burden that banks can impose on taxpayers. ...

I was initially swayed by Dean Baker's argument that the banks that caused the most trouble were "either pure investment banks or pure commercial banks" as noted above, and thus that reestablishing a forced separation between the two types of institutions would not do much to insulate us from crises in the future. By my view on this has also evolved along the same lines, e.g. that "With the repeal of Glass-Steagall, investment banks exploded in size and so did their market power" leading to "an opaque over-the-counter market populated by a few powerful dealers," that "The separation between investment and commercial banking also helps make the financial system more resilient," and that, importantly, "Glass-Steagall helped restrain the political power of banks." This should not be the only thing we do to try to make the financial system more stable, there is much,much more that needs to be done. But it is an important part of the effort. (One more note on this -- I also think that there were additional vulnerabilities created by the removal of Glass Steagall. Even if those additional vulnerabilities didn't cause trouble this time around, that doesn't mean they never can. Re-imposing the separation between investment banking and commercial banking eliminates some of these potential problems.)