Bernie Sanders’s claim that Glass-Steagall banned commercial bank loans to ‘shadow banks’
A key dispute between former secretary of state Hillary Clinton and Sen. Bernie Sanders in the race for the Democratic nomination is the role that the partial repeal of Glass-Steagall played in the 2008 financial crisis. Clinton’s husband, of course, in 1999 signed the law that helped break down the walls between investment banking firms and commercial banks.
Our goal here is not to re-litigate the 1999 legislation’s role in the Great Recession. Each side can muster experts to make their case, though in general we would note that few economic crises (like plane crashes) are the result of one single factor; there is a risk in overemphasizing one reason above others. Even Sen. Elizabeth Warren (D-Mass.), who favors reinstalling a version of Glass-Steagall, has acknowledged that crisis probably could not have been avoided if Glass-Steagall had been in place. (The Sanders campaign likes to cite this analysis blaming Glass-Steagall by the regulatory reform group Better Markets.)
So let’s look at Sanders’ specific claim here: That the “shadow banks” got their funds from the “federally insured bank deposits of big commercial banks — something that would have been banned under the Glass-Steagall Act.” Is that correct?
Commercial banks are very visible; they have branches throughout towns and cities, taking deposits and making loans to individuals and businesses. Investment banks are more oriented toward Wall Street, trading securities and raising money for companies through the underwriting of stocks and bonds.
Shadow banks also carry out traditional banking functions, but do so largely outside the purview of bank regulatory systems. The shadow-banking system includes money market funds and off-balance sheet investment vehicles such as collateralized debt obligations and credit default swaps. Another aspect of this market are repurchase agreements, essentially overnight loans for dealers in government securities. The size of the shadow-banking system, which can significantly reduce the cost of credit, has been estimated as high as $67 trillion.
But experts generally say this is incorrect.
“Commercial banks could have done all of those things in the 1960s or earlier, even before the Fed and the OCC [Office of the Comptroller of the Currency] and court decisions began to loosen the strictures of Glass-Steagall,” said Lawrence J. White, an expert on financial regulation at New York University’s Stern School of Business.
Phillip Wallach, a Brookings Institution fellow and author of “To The Edge: Legality, Legitimacy, and the Responses to the 2008 Financial Crisis,” agreed with that assessment: “Do they think commercial banks couldn’t make mortgages to whomever back under Glass-Steagall? That’s what commercial banks did! The rise of mortgage-backed securities doesn’t strike me as obviously inconsistent with Glass-Steagall (and obviously took off during the late part of the Glass-Steagall era).” He added: “I think they are stretching very hard to try to fit a square peg in a round hole, and it’s not at all convincing as a matter of accurate historical description.”
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The Pinocchio Test
We can find little support for Sanders’s statement that Glass-Steagall banned commercial banks from making loans to investment banking firms to facilitate their trading in the shadow-banking arena. Indeed, the two examples he cited did not fail because of loans received by commercial banks, according to the exhaustive government-sponsored investigation of the crisis. Indeed, in the case of AIG, the problems largely stemmed from a law that Sanders himself supported.
On a broader level, Sanders would be on more solid ground to argue that the commingling of investment and commercial banking functions permitted by the 1999 partial repeal allowed the growth of megabanks such as Citigroup that exacerbated the crisis. The observation of Rickards, the former hedge fund general counsel, that such shadow-bank loans routinely required Fed permission before the 1999 law is also instructive — though Rickards also says the 2000 law that Sanders supported was an important factor in the crisis.
We wavered between Two and Three Pinocchio. But this was a prepared — and important — speech by Sanders. So it’s essential to get the facts straight.
Three Pinocchios
https://www.washingtonpost.com/news/fact-checker/wp/2016/01/11/bernie-sanderss-claim-that-glass-steagall-banned-commercial-bank-loans-to-shadow-banks/
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