Two weeks ago, Citigroup’s former CEO John Reed said in an op-ed in The Financial Times that big banks are “inherently unstable and unworkable.” In his opinion, the Glass-Steagall Act should not have been repealed in 1999. The two biggest flaws he pointed out were that big banks have bad culture and are not more efficient than keeping financial institutions separate. However, according to Princeton professor Alan Blinder, this is a “widespread mistake in impression.” According to him, the repeal of the Glass-Steagall Act was not in fact what made big banks inefficient because the “positions of those institutions in the years 2006-07 had nothing to do with Glass-Steagall”. Rather, the banks that got into trouble or caused trouble, he noted, were mostly a group of investment banks that were not officially considered banks. Examples of these banks include Bank of America, Citibank, Wachovia, and Washington Mutual. However, the only one of these banks whose structure had anything to do with the repeal of Glass-Steagall was Citicorp, who merged with Traveller’s Insurance. The insurance business had nothing to do with the problems of Citibank, but rather the CEO of Citi at the time, Sanford Weill, was en empire builder. Before the repeal of the act, other banks that wanted to cross the line into investment banking were not as aggressive as Citi and could have done it under the existing regulations, but once the act was repealed, Citi was able to alter its structure for what it believed was maximal profitability.

Blinder does give merit, however, to Reed’s point that the culture of big banks could be worse than separate institutions. Once the act was repealed, there were two possible cultural changes that could have ensued. In one, the banking culture would sweep over the investment banking culture and the “burn ‘em and churn ‘em” attitude would be diminished. In the other, the worse outcome, the investment banking culture would over take the banking culture and the “burn ‘em and churn ‘em” attitude” would thrive.

Finally, Blinder made it a point to clear up the myth that the final repeal of Glass-Steagall in 1999 was a big deal, because it had, in fact, been tacitly repealed. Banks had been enabled by bank regulators to do more and more investment banking even under the act, and thus he does not believe that the repeal had as big of an impact on the industry as Reed does.


Alan Blinder

Written by thefinancier

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