Dodd-Frank and Glass-Steagall: 'Consumer Protection for Billionaires'

COMMENTARY Markets and Finance

Dodd-Frank and Glass-Steagall: 'Consumer Protection for Billionaires'

Jul 27, 2016 6 min read

Former Director, Center for Data Analysis

Norbert Michel studied and wrote about financial markets and monetary policy, including the reform of Fannie Mae and Freddie Mac.

It may be hard to believe, but I pay very little attention to presidential politics. People send me news clips and ask me what I think about what the candidates said, but I generally don’t indulge them.

This week, however, a friend sent me a clip from a Donald Trump Jr. speech that actually got my attention. Trump the younger, of course, is not running for political office. Still, it’s great that he understands one of the big problems with our financial regulatory framework. He said:

"Dodd-Frank was a thousand pages long and it’s already spun off 22,000 pages in regulations.

"Imagine trying to digest all that before you even open your doors for business. That doesn’t help consumers. What it does is destroy small business in favor of big businesses who can afford the vast number of lawyers and accountants needed to comply. Dodd-Frank is consumer protection for billionaires."

He nailed it. The Dodd-Frank Wall Street Reform and Consumer Protection Act did not reform Wall Street, and it did far more to protect billionaires and entrenched incumbent firms than it did to protect the little guy.

One reason is that all the “safety and soundness” regulations imposed by Dodd-Frank are little more than updated versions of what regulators have been doing for over a century. They’ve been piling them on, so it gets progressively worse, but it’s more of the same.

And unless we completely prohibit people from taking financial risks—which would make the world a very dull place—we can’t legislate and regulate away failure. It’s a lovely thought, but it simply can’t be done.

Another reason is the way that these regulations get implemented in an open society. It centers on basic self-interests.

Nobody in her right mind cares about how regulators define banks’ tangible equity and net derivative exposure. Neither would any sane person bother to lobby Congress or financial regulators so that they might influence the legal definition of highly liquid assets or net capital. Nor would anyone with a normal day-job bother to read a 1,000 page rule defining exactly what regulators view as proprietary trading.

The big exception, of course, is that people who work in commercial and investment banks care a great deal how regulators define these terms. In other words, self-interests dictate that a relatively small share of the population, one that is tightly connected to the financial industry, will pay close attention to these details.

The same goes for Congressman voting for bills like Dodd-Frank. Most of them, rightly so, rely on other people to advise them.

As long as our system of government allows citizens to have input, regulatory agencies will necessarily craft rules by working with the people most interested in these issues. It’s unavoidable that this process results in financial regulations influenced most heavily by the existing firms that stand to gain—or lose—the most because of those rules.

Even when it’s not by nefarious design, we end up with rules that favor the largest/best-funded firms over their smaller/less-well-funded competitors. Put differently, our massive regulatory state ends up keeping large firms’ competitors at bay.

The more detailed regulators try to be, the more complex the rules become. And the more complex the rules become, the smaller the number of people who really care. Hence, more complicated rules and regulations serve to protect existing firms from competition more than simple ones.

All of this means consumers lose. They pay higher prices, they have fewer choices of financial products and services, and they pretty much end up with the same level of protection they’d have with a smaller regulatory state.

Exactly the same principles apply to the notoriously controversial Glass-Steagall Act.

All sorts of policymakers have been clamoring to reinstate Glass-Steagall to protect us from financial crises. They wrongly assume that Glass-Steagall “repeal” caused the crisis, and go further astray by assuming Glass-Steagall actually protected consumers in the first place.

In reality, the 1933 Glass-Steagall restrictions protected Wall Street investment banks from their commercial bank competition (and vice versa). After WWI, when the government pressed financial firms into service to sell more war bonds, commercial banks realized they could sell securities to the general public. So they did. And Wall Street didn’t like it.

One of the most successful was National City Bank. By the time the Senate was through with him, National City’s Chairman Charles E. Mitchell’s reputation was ruined, but he was found not-guilty of all criminal charges.

His biggest sin was his success.

National City Bank’s securities underwriting affiliate, National City Company, purchased smaller investment dealers all over the country and built a large retail sales force. In the eyes of traditional Wall Street (wholesale) investment banks, National City Company was a leader in “high-pressure selling,” a practice that ran counter to their staid traditions.

So the Wall Street bankers, largely through their trade group, the Investment Bankers Association of America (IBAA), lobbied for (and won) laws that would put an end to these practices. And they did it all in the name of improving the securities industry professionals’ ethical standards.

By way of a series of 1930s securities laws (not solely, but including Glass-Steagall), the industry was changed dramatically and the U.S. ended up with an otherwise pointless split between retail and wholesale investment banking, as well as the senseless split between commercial and investment banking.

One consequence was the creation of two distinct sets of financial companies with less diversified risks than before. In layman’s terms, it was harder for these firms, especially the commercial banks, to avoid putting all of their eggs into one basket.

The sad thing is that the empirical evidence shows there was no reason to separate the two types of financial companies. (One of the best places to start, if interested, is George Benston’s book).

We know for example that, prior to Glass-Steagall, banks engaged in both types of financial activities had lower failure rates during this period. From 1930 to 1933, 26.3 percent of all national banks failed, but only 6.5 percent of the 62 banks with securities affiliates as of 1929 failed. Similarly, only 7.6 percent of the 145 banks with large bond operations failed.

There simply is no statistical foundation for arguing integrated commercial and investment banking was riskier than specialized commercial banking, or that it caused the Great Depression. A close look at what Glass-Steagall actually did also shows how difficult it was to “separate” commercial and investment banking, a feat that would be even more complicated now.

There are so many misconceptions surrounding Glass-Steagall it’s hard to fathom how it earned any sort of positive reputation at all. Here’s a brief list of Glass-Steagall facts – some from the 1930s and some from the recent debate – that often get ignored:

The earliest and most noteworthy financial disasters during the 2008 crisis were at pure investment banks (Lehman, Bear Stearns, Merrill Lynch) and pure commercial banks (Washington Mutual, Wachovia).

Glass-Steagall-type restrictions, even a modernized version, would not prevent banks from taking “risky bets” with insured deposits unless the restrictions prevent banks from making consumer and commercial loans.

Many analysts, historians, and even some court cases, cite abusive and reckless investment practices Congress supposedly uncovered prior to passing the Glass–Steagall Act. A careful examination shows these claims almost always refer to secondary sources rather than the original record, or to opinions and allegations rather than actual evidence of abuses.

The Glass–Steagall separation applied only to U.S. banks’ domestic operations. Internationally, U.S. commercial banks regularly offered securities services. By the 1980s the top 30 Eurobond underwriters were U.S. bank affiliates. Citicorp offered investment banking services in over 35 countries, and Chase Manhattan had offices in almost twice as many countries as 10 major investment banks combined.

Ferdinand Pecora, Chief Counsel for the Senate Committee on Banking and Currency, conducted politically successful hearings in 1933 and 1934 that won him the nickname The Hellhound of Wall Street. Virtually none of the more than 11,000 pages of testimony from these hearings provides evidence regarding the safety and soundness of commercial banks and their securities affiliates.

Much like the frenzied environment on Capitol Hill during the 2008 financial crisis and the passage of the 2010 Dodd–Frank Act, most of the Glass–Steagall-related hearings were more focused on casting blame than shedding light on – and actually fixing – the problems that caused the crash.

In both instances we ended up with legislation that tried to design financial markets by dictating precisely who can take which financial risks. This approach does not make markets safer.

It harms consumers via higher prices, fewer choices, and less opportunity because it protects firms from competing for consumers. It’s consumer protection for billionaires.

It was true in the 1930s and it’s true now.

Originally published in Forbes. This and more can be found at