Glass-Steagall and the Economic Crisis

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Monday, 21 May 2012 21:47

Andrew Ross Sorkin seems to be very proud of himself for having figured out that Glass-Steagall would not have prevented the economic crisis that hit the economy in 2007 and is still causing tens of millions of people to be out of work or underemployed today. He is of course right, except most of us knew this 4 years ago.

The crisis, which is an "economic crisis" not a "financial crisis" was caused by the collapse of an $8 trillion housing bubble. This bubble was driving the economy by sparking both a construction boom and a consumption boom. When house prices came back down to earth, these sources of demand evaporated and there was nothing to replace them. It's a fairly simple story for those of us who learned arithmetic back in third grade.

Glass-Steagall played no direct role in the crisis or the buildup to it. Nonetheless, it does get to heart of one of the big unnecessary freebies that the government gives to the financial sector. The point of the law was that if you held government-guaranteed deposits then there should be restraints on the sort of risks you can take.

It is understandable that the spoiled brats who run big banks on Wall Street think that they should be able to get handouts from the government with no strings attached, but that is not the way a market economy is supposed to work. If the banks don't want the government's guarantees for its deposits, no one is forcing them to take the guarantee. But, if they take the guarantee, then they don't get to take big risks like Jamie Dimon's big bet.

This tradeoff is pretty straightforward. Even an NYT business columnist should be able to figure it out.