Part of the problem with the candidacy of Hillary Clinton for President is that she is not free to set policy. \u00a0Surprisingly she has been supported by sophisticated banking Senator from Ohio, Sherrod Brown. \u00a0But can she ever resurrect Glass Steagall (if she gets the chance?) \u00a0Probably not. \u00a0A serious glitch in her potential Presidency.<\/p>\n
SImon Johnson writes: \u00a0A major shift in American politics has taken place. All three of the remaining mainstream Democratic presidential candidates now agree that the existing state of the financial sector is not satisfactory and that more change is needed. President Barack Obama has long regarded the 2010 Dodd-Frank financial-reform legislation as bringing about sufficient change. Former Secretary of State Hillary Clinton, Senator Bernie Sanders, and former Governor Martin O\u2019Malley want to do even more.<\/p>\n
The three leading Democratic candidates disagree, however, on whether there should be legislation to re-erect a wall between the rather dull business of ordinary commercial banking and other kinds of finance (such as issuing and trading securities, commonly known as investment banking).<\/p>\n
This issue is sometimes referred to as \u201creinstating Glass-Steagall,\u201d a reference to the Depression-era legislation \u2013 the Banking Act of 1933 \u2013 that separated commercial and investment banking. This is a slight misnomer: the most credible bipartisan proposal on the table takes a much-modernized approach to distinguishing and making more transparent different kinds of finance activities. Sanders and O\u2019Malley are in favor of this general idea; Clinton is not (yet).<\/p>\n
Some prominent former officials argue that not all of the financial firms that got into trouble in 2008 were integrated commercial-investment banking operations. For example, Lehman Brothers was a standalone investment bank, and AIG was an insurance company.<\/p>\n
This argument is, at best, irrelevant. What happened \u201clast time\u201d is rarely a good guide to fighting wars or anticipating future financial crises.<\/p>\n
At worst, the argument is just plain wrong. Some of the greatest threats in 2008 were posed by banks \u2013 such as Citigroup \u2013 built on the premise that integrating commercial and investment banking would bring stability and better service.<\/p>\n
Second, leading representatives of big banks argue that much has changed since 2008 \u2013 and that big banks have become significantly safer. Unfortunately, this is a great exaggeration.<\/p>\n
Ensuring a financial system\u2019s stability is a multifaceted endeavor \u2013 complex enough to keep many diligent people fully employed. But it also comes down to this: how much loss-absorbing shareholder equity is on the balance sheets of the largest financial firms?<\/p>\n
In the run-up to the 2008 crisis, the largest US banks had around 4% equity relative to their assets. This was not enough to withstand the storm.<\/p>\n
Now, under the most generous possible calculation, the surviving megabanks have on average about 5% equity relative to total assets \u2013 that is, they are 95% financed with debt.<\/p>\n
Consider all the instances of money laundering and sanctions busting with evidence against Credit Agricole last week, Deutsche Bank this week, and almost every major international bank in the past few years.<\/p>\n
This is the equivalent of near misses in aviation. If the US had the equivalent of the National Transportation Safety Board for finance, we would receive detailed public reports on what exactly is \u2013 still, after all these years \u2013 going wrong. Sadly, what we actually get is plea bargains in which all relevant details are kept secret.<\/p>\n
The best argument for a modern Glass-Steagall act is the simplest. We should want a lot more loss-absorbing shareholder equity.<\/p>\n
Building support for legislation to simplify the biggest banks would greatly strengthen the hand of those regulators who want to require more shareholder equity and better regulation for the shadows. These policies are complements, not substitutes.<\/p>\n
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