Glass-Steagall Redux

Here’s a fun experiment for your next ______ (cocktail party, bat mitzvah, ultimate croquet challenge, etc.): ask a proponent of the Volcker Rule what caused the the global financial crisis of ’08-’09. 

What’s that?  The cocktail parties you attend don’t include conversations about financial regulations?   

I’m shocked.  

Well, wherever you’re able to find yourself a VR proponent, I’ll bet you a nickel that the first (and maybe only) catalyst she cites will be the 1999 repeal of Glass-Steagall.  

As a refresher, “Glass-Steagall” (officially the Banking Act of 1933) was the Depression era act which separated commercial banking activities (taking deposits, making loans) from investment banking activities (underwriting, securities trading, brokerage). 80 years ago, Congress felt that the business of lending was less risky, or at least that sort of risk could be contained more easily than trading & underwriting.  If taxpayers were going to provide a backstop for banks via the newly formed FDIC, Congress wanted to make sure that banking risk was minimized.  

It's not a bad notion.  The benefit taxpayers receive (a sound banking system) is much less tangible than the risk they bear (potentially pony-ing up for failed banks), so it made some public relations sense to put a short leash on banks.   

Although, risk avoidance is not risk management and the VR (and Glass-Steagall) is all about risk avoidance. 

Why?  Well, mainly, the Vocker Rule proponents are members of the “Regulate First, Aim Later” brigade.  This advocacy blinds them to the importance of the larger analytical question: what factors led to the financial crisis?  It’s not a terribly difficult question.  Here are some of the ones I see:     

1. Extraordinarily low interest rates coming out of the 2001 recession
   
2. 30:1 leverage ratios at hedge funds
   
3. Private investment banks converting to public companies
4. The Community Reinvestment Act and related GSE mandates
5. Moral hazard at Fannie Mae & Freddie Mac 
6. A large insurance holding company (AIG) acting as an unregulated derivative clearing house
7. Insufficient bank capital standards
8. And MAYBE the repeal of Glass-Steagall

I say maybe in #8 because I really can't see what sort of systemic risk is posed by adequately capitalized banks, regardless of which types of business activities they pursue.

It’d take too long to go into each of these, so knock yourself out on Wikipedia.  What factors would you add?
  

Wouldn't it be nice if we could boil a massive financial crisis down to a single variable?  Unfortunately, we can’t.  If we construct our regulatory regime on that basis, we'll get into trouble again.    Analysis suggests that there were many factors creating this perfect storm, not simply the repeal of Glass-Steagall.