Edit: I've put a lot of work into the comment below, so I would appreciate if you'd read it and respond to it. I know it's harder to discuss the specific provisions of Glass-Steagall and its affect on the market place than just saying "oh, the Glass-Steagall repeal is responsible for everything wrong". However, if people are going to cite the argument so often that it becomes the commonly accepted viewpoint, then it ought to be incumbent on them to UNDERSTAND it. Anything else is hand-waving.

I hear this a lot, too, but it's hard for me to see how the Glass-Steagall Act repeal had anything to do with the current crisis. In fact, deregulation seems to have mitigated the damage. The reorganization of Bear, Merrill, Morgan, and Goldman would have been impossible were the Glass-Steagall Act still in full force. They would have all gone bankrupt or had to be rescued by the government. Many of the entities that are in good financial shape are the large financial conglomerates that would have been illegal were G-S still in place. Customer bank deposits provide a stable source of funding when lenders are skitish. Reducing the supply of capital in an embattled industry would be the height of stupidity.

Many foreign countries never had any law like Glass-Steagall in place and they don't seem to be suffering the same problems. As logic tells us, the current crisis seems to be orthogonal to the presence or absence of Glass-Steagall.

Mcardle also had a wonderful post FACTUALLY summarizing the provisions of Glass-Steagall and its relation to the current crisis:

http://meganmcardle.theatlantic.com/archives/2008/09/clear_a...

I also addressed this issue on my libertarian blog a while back:

http://distributedrepublic.net/archives/2008/09/22/the-end-e...

A large problem during the Great Depression was that the United States had laws that artificially limited the size of banks (see "Unitary Branching Laws"). The result was that institutions in the United States had smaller financial cushions in crisis time and were more likely to go under. The United States suffered a FAR higher rate of bank failure than other countries, and states with unitary branching laws had higher failures than those without.

So I know blaming the Glass-Stegall repeal for our current problems is popular(populist) wisdom, but it seems to me that popular wisdom is, as usual, wrong.

> They would have all gone bankrupt or had to be rescued by the government

But isn't the point to separate the investment banks away from the savings banks? There's a fundamental type difference between a dollar earned and saved, and a promissory-based dollar conjured up by a debt instrument.

When an investment bank fails (as it should when it's made a bad mortal investment), the funny money dries up, leaving the holder high and dry. If this holder employed bad accounting (by counting promised dollars as dollars-in-hand), then they may fail as well (and so on). However, this should not continue into the institutions that hold the savings of the people who didn't want to play economic make-believe.

> Many foreign countries never had any law like Glass-Steagall in place and they don't seem to be suffering the same problems

How many other countries have currencies that are used as reserve by the rest of the world? (which greatly lengthens the time for consequence of inflationary policy to be felt)

  If this holder employed bad accounting (by counting promised dollars as dollars-in-hand), then they may fail as well (and so on).

That's called accrual accounting, and is required by United States Generally Accepted Accounting Principles, International Financial Reporting Standards, and the UK's Companies Act.

What I mean is if the holder only employed such accounting. I can see how such figures are normally useful, but the abstraction can break down when you aren't paid (and in this case, did so catastrophically). If your investment bank wants to survive downturns, it should be factoring this possibility into its decisions.

"However, this should not continue into the institutions that hold the savings of the people who didn't want to play economic make-believe."

How are these savings going to provide any interest if they are not redistributed as loans? The whole point of a bank is to allow your money to work for you while also providing loan capital to those who have a good use for it. It's impossible to have a non-negative (due to administrative costs) savings account without loaning the money to someone.

Or am I completely missing your point?

Home/business loans made by a savings bank are subject to the reserve requirements. If these loans turn out to be bad and cause bank insolvency, the amount isn't huge because we're dealing with first-order numbers mostly backed by collateral. When the FDIC steps in to repay depositors, no money is lost (besides the bank's investors).

Okay, I hoped that's what you meant, and not that savings banks should not be allowed to invest or loan money at all.

I didn't say Glass-Steagall being repealed was responsible for everything that was wrong. But having it in place would have kept our institutions smaller with fewer entanglements, therefore fewer firms would be in the "too big to fail" category. True, it would have prevented a few of the mergers that are happening now but they may not have been necessary. Once you eliminate the problem of one institution bringing down the entire financial system, the existing bankruptcy courts are a better mechanism for unwinding bad assets.

> "Many foreign countries never had any law like Glass-Steagall in place and they don't seem to be suffering the same problems. As logic tells us, the current crisis seems to be orthogonal to the presence or absence of Glass-Steagall."

I don't buy into that logic. Just because every financial system in the world hasn't failed due to too much deregulation, doesn't mean deregulation is bad or not the cause of our current crisis. There are a multitude of things contributing to the current problem, but excessive regulation and checks and balances aren't one of them.

We don't necessarily need to reinstate Glass-Steagall, but we need a modern-day equivalent. We need to ensure financial institutions can fail without jeopardizing the entire economic system. I'm personally in favor of something along the lines of the DoJ anti-trust mechanism, with an independent body that analyzes financial mergers and assets from the perspective of whether they are dangerous to the economy and citizens. On the other hand, I don't feel that our current DoJ is working very well so maybe that's not the best idea. I'm open to suggestions.