Destroyers of Glass Steagall Deserve Their Share of the Blame

Attorney H. Rodgin Cohen, one of the wise men of Wall Street, says in a video interview with The Deal that the 1999 repeal of Glass-Steagall wasn't "responsible" for the financial crisis.

Cohen, who this spring was briefly under consideration for the No. 2 job at the Treasury Department, is either engaging in lawyerly parsing or is willfully ignoring history. Because, as he understands better than most, no single cause or event is responsible for what happened.

Abolishing Glass-Steagall, which among other things kept commercial and investment banks separate, no more precipitated the collapse than did, say, the Commodity Futures Modernization Act. That law, adopted in 2000 under then-President Bill Clinton, exempted credit default swaps from regulation. And we know how well that worked out.

Nor was the crisis primarily caused by borrowers' and banks' infatuation with subprime mortgages, nor the securitization of these loans. Nor the push by institutional investors, sprinting after beta, to plow their money into heavily leveraged, unregulated hedge funds. The weak performance of corporate boards leading up to the meltdown, too, isn't chiefly to blame. And neither is the pay-to-play business model of credit rating agencies. Same goes for cheap money and the infelicities of debt. Swollen banker bonuses? Innocent as charged.

None of these things is uniquely responsible for the financial crisis, to borrow Cohen's formulation, because all of them are. Cause turns into effect and, caught within the market's perpetual feedback loop, back again.

As he correctly points out, inadequate government oversight is another culprit. Exactly who pulled the trigger in this bloodiest of drive-bys is a matter of conjecture, or perhaps ideology. But Glass-Steagall's killers were somewhere in the vehicle.

The end of Glass-Steagall didn't merely signify a new order in financial services. It represented a triumph of ideas. One of these was that banks can be left alone to engage in risky trading activities, with only "market discipline" to keep them correct.

Cohen points to financial institutions such as Bear Stearns and Washington Mutual, neither of which engaged in both commercial and investment banking, to prove that the central problem lies outside this commingling of services.

But the problems of other diversified banks, such as Citigroup and UBS, tell a different story. The Swiss financial giant, which lost more money during the crisis than any other bank, drew heavily on its commercial banking funds to expand and leverage its fixed-income business (Today it's going back for more.) Citi, formed in 1998 through its merger with Travelers Group (and Salomon Brothers, a unit of the insurance company), used its newly acquired investment banking chops to get into mortgage securitization, which later cost it a bundle.

In both cases, one set of ideas grounded in the culture of investment banking, where risk is embraced, overcame an ethos rooted in commercial banking, where risk (once) was feared. The casino plundered the vault. And that mentality pervaded financial services. It even brought down the companies Cohen cites as Glass-Steagall's main alibi.

That culture wasn't born in the late '90s, it's worth noting. The push to open up financial services a decade ago was the capstone (or the gravestone) on a years-long campaign to clear-cut the industry of regulation.

And in this sense, at least, Cohen is right -- the end of Glass-Steagall isn't solely responsible for the financial crisis. But to absolve its demise entirely is itself an evasion of responsibility.