THE DODD-FRANK WALL STREET REFORM AND
CONSUMER PROTECTION ACT: A MISSED
OPPORTUNITY TO REIN IN TOO-BIG-TO-FAIL
BANKS
Christian Evans*
“Almost all significant laws and regulations are done in this country in
times of crisis.” -Franklin Delano Roosevelt
INTRODUCTION .................................................................................. 43
HISTORY............................................................................................... 45
I. The Securities Business Prior to the Great Depression ......... 45
II. The Glass-Steagall Act ........................................................... 46
III. The Economic Landscape from 1933 to 1999 ........................ 47
IV. The Gramm-Leach-Bliley Act................................................. 49
V. The Era of Big Banking and Unprecedented Bailouts............ 50
VI. The Dodd-Frank Wall Street Reform and Consumer
Protection Act......................................................................... 51
ANALYSIS ............................................................................................ 52
I. Is a Return to Glass-Steagall Practical?................................ 52
II. Too-Big-To-Fail Banks........................................................... 54
A. The Dangers Associated with Too-Big-To-Fail
Banks and Government Bailouts .................................. 54
B. The Financial Crisis of 2008.......................................... 55
CONCLUSION ...................................................................................... 57
INTRODUCTION
The financial crisis of 2008 has been called the worst economic disaster
since the Great Depression.1 In the 1930s, during the Great Depression,
President Roosevelt looked to Congress to overhaul the financial sector.2 He
wanted the regulatory loopholes that contributed to the crisis sealed off.3 In
* J.D. Candidate Spring 2012, Duquesne University School of Law; M.B.A. Candidate
Spring 2012, University of Pittsburgh; B.A., History, Boston University, 2006.
1. Joseph Lazzaro, Soros Calls Financial Crisis Worst Since Great Depression, Sees
More Market Declines, Blogging Stocks (Apr. 3, 2008, 1:04 PM), http://www.bloggingstocks.com/2008/04/03/soros-calls-financial-crisis-worst-since-great-depression-sees/.
2. A.C. Pritchard, Populist Retribution and International Competition in Financial
Services Regulation, 43 CREIGHTON L. REV. 335, 338 (2010).
3. Id.
43
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response, Congress assembled a bill that was designed to prevent a future
financial catastrophe of that magnitude by mandating the separation of
commercial and investment banks.4 It was referred to as the Glass-Steagall
Act.5
Over the next sixty years, special interest groups worked diligently to
erode the provisions promulgated under the Glass-Steagall Act.6 Finally, in
1999, in response to constant pressure from the banking industry, the GlassSteagall Act was repealed by the Gramm-Leach-Bliley Act (“GLBA”).7
4. Joseph Karl Grant, What the Financial Services Industry Puts Together Let no Person
Put Asunder: How the Gramm-Leach-Bliley Act Contributed to the 2008 - - 2009 American
Capital Markets Crisis, 73 ALB. L. REV. 371, 377 (2010).
5. Id. “The Glass Steagall Act has come to mean only those sections of the Banking Act
of 1933 that refer to banks’ securities operations--sections 16, 20, 21, and 32.” Edum Ofer,
Glass-Steagall: The American Nightmare That Became the Israeli Dream, 9 FORDHAM J.
CORP. & FIN. L. 527, 529 (2004). Section 16 of the Banking Act of 1933 provides in pertinent
part that:
[national banks that are in] the business of dealing in securities and stock by the association shall be limited to purchasing and selling such securities and stock without recourse, solely upon the order, and for the account of, customers, and in no case for its
own account, and the association shall not underwrite any issue of securities or stock.
Banking Act of 1933 § 16, 48 Stat. 162 (1933) (Current version available at 12 U.S.C.A. §
24(7) (West 2010)). Section 20 prohibited member banks of the Federal Reserve System to
affiliate with any entity “engaged principally in the issue, flotation, underwriting, public sale,
or distribution at wholesale or retail or through syndicate participation of stocks, bonds, debentures, notes, or other securities.” Banking Act of 1933 § 20, 48 Stat. 162 (1933) (repealed
1999). Section 21 provides that:
it shall be unlawful for any [entity] engaged in the business of issuing, underwriting,
selling, or distributing, at wholesale or retail, or through syndicate participation, stocks,
bonds, debentures, notes, or other securities, to engage at the same time to any extent
whatever in the business of receiving deposits, [and] that the provisions of this paragraph shall not prohibit banks… from dealing in, underwriting, purchasing, and selling
investment securities, or issuing securities, to the extent permitted to national banking
associations by the provisions [provided in Section 16].
Banking Act of 1933 § 16, 48 Stat. 162 (1933) (current version available at 12 U.S.C.A. §
378(a)(1) (West 2010)). Section 32 prohibited officers, directors, or employees of an entity
“primarily engaged in the issue, flotation, underwriting, public sale or distribution, at wholesale or retail, or through syndicate participation, of stocks, bonds, or other similar securities”
from serving as an officer, director or employee of a member bank of the Federal Reserve
System. Banking Act of 1933 § 32, 48 Stat. 162 (1933) (repealed 1999).
6. Grant, supra note 5, at 379-80.
7. Id. at 380. The Gramm-Leach-Bliley Act repealed sections 20 and 32 of the GlassSteagall Act, which:
prohibited a bank holding company from engaging in securities underwriting and other
non-banking activities and amended the Bank Holding Company Act to allow holding
companies to engage in activities that are “financial in nature or incidental to such financial activity; or . . . complementary to a financial activity [if it] does not pose a substantial risk to the safety or soundness of depository institutions or the financial system
generally.
Roshni Banker, Glass-Steagall Through the Back Door: Creating a Divide in Banking Functions Through the Use of Corporate Living Wills, 2010 COLUM. BUS. L. REV. 424, 435-36
(2010). See Gramm-Leach-Bliley Act, 15 U.S.C.A. §§ 6801-6809 (West 2010).
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Nine years later, the United States suffered its worst financial crisis since the
Great Depression.8
It is inarguable that the financial crisis of 2008 was one of the most devastating events in the history of the United States. But it also presented a rare
opportunity for Congress to enact a substantial piece of legislation to rectify
a broken banking system that was controlled by a small number of big
banks.9 Unfortunately for the American people, Congress failed to take full
advantage of the situation by assembling a watered-down bill entitled the
Dodd-Frank Wall Street Reform and Consumer Protection Act (“DoddFrank”).10
HISTORY
I.
The Securities Business Prior to the Great Depression
With the hope of creating a national banking system and a national currency, Congress enacted the National Bank Act of 186411 with a federal
chartering option which allowed member banks of the Federal Reserve System to issue bank notes (currency) that were backed by Treasury bonds.12
Although this piece of legislation encouraged national banks to deal in government bonds, they were prohibited from underwriting13 corporate securities.14 As a result, many national banks struggled to compete with state
banks that were free to engage in underwriting and dealing activities.15
The inability to effectively compete with state banks forced national
banks to devise a method in which they could indirectly engage in the securities business.16 Many of the larger national banks realized that they could
circumvent the underwriting restrictions by setting up separate but affiliated
8. Banker, supra note 8, at 425.
9. Ann Graham, Bringing to Heel the Elephants in the Economy: The Case for Ending
“Too Big To Fail,” 8 PIERCE L. REV. 117, 142 (2010).
10. The Monitor, Banking & Financial Services Policy Report, 29 NO. 7 BANKING & FIN.
SERVICES POLY REP., at 22 (2010). See The Dodd-Frank Wall Street Reform and Consumer
Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (to be codified at 12 U.S.C. § 5301).
11. National Bank Act of 1864, ch. 106, 13 Stat. 99 (1864).
12. William F. Shughart, A Public Choice Perspective of the Banking Act of 1933, CATO
JOURNAL, Vol. 7 No. 3, 595, 597 (Winter 1988), http://www.cato.org/pubs/journal/
cj7n3/cj7n3-3. A Treasury bond is “a long-term debt security issued by the federal government, with a maturity of 10 to 30 years.” BLACK’S LAW DICTIONARY 1257 (8th ed. 2004).
13. Underwriting is “the act of agreeing to buy all or part of a new issue of securities to
be offered for public sale.” Id. at 1275.
14. Shughart, supra note 13, at 597. A security is an instrument that evidences the
holder’s ownership rights in a firm (e.g. a stock), the holder’s creditor relationship with a firm
or government (e.g. a bond), or the holder’s other rights (e.g. an option). BLACK’S LAW
DICTIONARY 1124 (8th ed. 2004).
15. Jerry W. Markham, The Subprime Crisis--A Test Match for Bankers: Glass-Steagall
vs. Gramm-Leach-Bliley, 12 U. PA. J. BUS. L. 1081, 1085 (2010).
16. Id. at 1086.
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securities firms.17 Smaller national banks, however, were forced to choose
between remaining a member of the of the Federal Reserve System or dropping out of the Federal Reserve System to compete in the securities business.18
In 1927, Congress took notice of this phenomenon and passed the
McFadden Act19 so that national banks could freely deal in corporate securities.20 Soon after the underwriting and dealing restrictions were lifted,
commercial banks began to dominate the securities business.21 By 1929, 459
banks in the United States were underwriting securities directly through their
bond departments while 132 banks were investing in securities through an
affiliate.22 By the 1930s, commercial banks were underwriting over half of
all new securities issued.23
II.
The Glass-Steagall Act
In October 1929, two years after the enactment of the McFadden Act, the
stock market crashed.24 Widespread panic swept across the United States as
banks began to fail.25 In an effort to allay the anxiety of the American people and mitigate the effects of a dismal financial market, Congress passed
the Glass-Steagall Act.26
The Glass-Steagall Act was enacted to end what Congress perceived to be
financial abuses that led to the Great Depression: the involvement of banks
in the trading and owning of speculative securities.27 In essence, the GlassSteagall Act erected a firewall between commercial banks and investment
banks.28 It not only prohibited commercial banks from engaging in investment banking activities, but it also made it illegal for a bank to be affiliated
with an investment organization.29
17. Shughart, supra note 13, at 597.
18. Id. at 598.
19. The McFadden Act, Pub. L. No. 69-639, 44 Stat. 1224 (1927).
20. Shughart, supra note 13, at 598.
21. Id. at 597.
22. Id. at 599.
23. Id. at 598.
24. Id. at 599.
25. Shughart, supra note 13, at 599. From 1929 through 1933, nearly 10,000 banks failed
as depositors and bank owner-managers scrambled for liquidity; 4000 banks closed their
doors in 1933 alone. Id.
26. Grant, supra note 5, at 377.
27. Inv. Co. Inst. v. Camp, 401 U.S. 617, 630 (1971). A speculative security is “a security that, as an investment, involves a risk of loss greater than would usually be involved; esp.
a security whose value depends on proposed or promised future promotion or development,
rather than on present tangible assets or conditions.” BLACK’S LAW DICTIONARY 1126 (8th ed.
2004).
28. Grant, supra note 5, at 377-78.
29. Camp, 401 U.S. at 629.
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The reasoning behind Congress’s actions stemmed from the fact that
commercial banks could not fulfill their role as disinterested lenders and
advisors while they promoted securities.30 Obviously, Congress feared that
such a relationship might induce a commercial bank to invest its own assets
in the securities activity of an affiliate.31 But what alarmed Congress more
were the subtle temptations that may arise within such a relationship.32
More specifically, Congress feared that commercial banks would be tempted
to make unsound loans to a variety of different entities.33 For example, loans
may be given to a struggling investment affiliate so that public confidence in
the bank’s name remained unimpaired,34 or a risky loan may be made to a
company in whose stock or securities the affiliate had invested.35 Banks
could also choose to give loans to customers based on the expectation that
the loaned money would be reinvested in the bank’s securities.36 Whatever
the temptation, Congress knew that legislation was needed to curtail unethical banking activities,37 and the best way to prevent these fundamental conflicts of interest was to create a barrier between commercial banks and their
securities subsidiaries.38
III. The Economic Landscape from 1933 to 1999
A few decades after the enactment of the Glass-Steagall Act, an effort was
made to limit its application.39 Beginning in the 1960s, commercial banks
began to lobby Congress for permission to operate in the municipal bond40
30. Sec. Indus. Ass’n v. Bd. of Governors of Fed. Reserve System, 468 U.S. 137, 154
(1984).
31. Camp, 401 U.S. at 630.
32. Id. Congress did not fear that commercial banks would invest their own assets in an
affiliate’s investment activities because most “affiliates had operated without direct access to
the assets of the bank.” Id. Rather, “securities affiliates were frequently established with
capital paid in by the bank's stockholders, or by the public, or through the allocation of a legal
dividend on bank stock for this purpose.” Id.
33. Id. at 630.
34. Camp, 401 U.S. at 631. It would be advantageous for a bank to invest in a struggling
affiliate so that public confidence in the bank remains unimpaired. Id. After all, public confidence in a bank is essential to its solvency. Id.
35. Id.
36. Id. at 632.
37. Camp, 401 U.S. at 632. There was a fundamental “conflict [that existed] between the
promotional interest of the investment banker and the obligation of the commercial banker to
render disinterested investment advice.” Id. at 633.
38. Id. at 634. Prior to the enactment of the Glass-Steagall Act, Senator Bulkley explained that “if we want banking service to be strictly banking service, without the expectation of additional profits in selling something to customers, we must keep the banks out of the
investment security business.” Id.
39. Banker, supra note 8, at 432.
40. A municipal bond is “a bond issued by a nonfederal government or governmental
unit, such as a state bond to finance local improvements.” BLACK’S LAW DICTIONARY 148 (8th
ed. 2004).
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market.41 In the 1970s, the New York Stock Exchange loosened its rules by
allowing brokers and dealers to become publicly traded companies.42 Over
the next few decades, investment banks slowly shifted into a public-holdingcompany43 structure.44 As regulators permitted these entities to cross into
the jurisdiction of other regulators, the barriers erected by the Glass-Steagall
Act slowly began to crumble.45
By the 1980s and early 1990s, the deregulatory process began to gain
momentum as a concerted effort to loosen the restrictions imposed by the
Glass-Steagall Act took hold.46 In 1986, the Federal Reserve Board reinterpreted Section 20 of the Glass-Steagall Act so that a commercial bank could
become affiliated with a firm that participated in underwriting securities so
long as less than five percent of the firm’s gross revenue was derived from
investment banking activities.47 In 1987, the Federal Reserve Board continued to deregulate the banking industry by allowing banks to engage in certain underwriting activities.48 Then, in 1989, the Federal Reserve Board
gave banks the permission to deal in debt49 and equity50 securities.51 In
1996, the revenue limit for affiliates engaged in investment activities was
raised again; bank holding companies were now permitted to own investment firms which derived twenty-five percent of their gross revenue from
investment banking activities.52 Finally, in 1998, the Federal Reserve Board
allowed Citicorp, the largest bank holding company in the United States, to
merge with a financial conglomerate.53 By the late 1990s, the regulations
41. Banker, supra note 8, at 433.
42. Onnig H. Dombalagian, Requiem for the Bulge Bracket?: Revisiting Investment Bank
Regulation, 85 IND. L.J. 777, 787 (2010).
43. A holding company is “a company formed to control other companies, usually confining its role to owning stock and supervising management.” BLACK’S LAW DICTIONARY 236
(8th ed. 2004).
44. Dombalagian, supra note 43, at 788.
45. Id. at 789.
46. Banker, supra note 8, at 433.
47. Id. The Federal Reserve Board reinterpreted “engaged principally” to mean that
“more than 5 percent of the firm's gross revenue must derive from investment-banking activity.” Id.
48. Id. at 434. The Federal Reserve Board voted on this resolution following extensive
lobbying from Citicorp, J.P. Morgan, and Bankers Trust. Id. Paul Volcker, the Federal
Chairman at that time, was vehemently opposed to such an allowance. Banker, supra note 8,
at 434.
49. A debt security is “a security representing funds borrowed by the corporation from
the holder of the debt obligation.” BLACK’S LAW DICTIONARY 1125 (8th ed. 2004).
50. An equity security is “a security representing an ownership interest in a corporation
(such as a share of stock) rather than a debt security (such as a bond).” Id.
51. Banker, supra note 8, at 434. The revenue limit for an affiliate engaged in investment
activities was also raised to ten percent in 1989. Id.
52. Id.
53. Arthur E. Wilmarth, Jr., The Dark Side of Universal Banking: Financial Conglomerates and the Origins of the Subprime Financial Crisis, 41 CONN. L. REV. 963, 972 (2010).
“In 1998, the [Federal Reserve Board] FRB took a more dramatic step by allowing Citicorp,
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promulgated under the Glass-Steagall Act had nearly disappeared altogether.54 Commercial banks were able to engage in several investment activities such as selling investment and insurance products, and operating
securities affiliates.55
IV. The Gramm-Leach-Bliley Act
On November 12, 1999, any surviving remnants of the Glass-Steagall Act
were officially destroyed with the enactment of the Gramm-Leach-Bliley
Act.56 The GLBA allowed commercial banks to affiliate with securities
firms.57 It also amended the Bank Holding Company Act58 to permit affiliation between commercial banks, insurance companies, and securities firms
within a financial holding structure.59
Advocates of the GLBA argued that, in order to compete in a global financial marketplace, it was imperative that U.S. banks operated independent
from stringent banking regulations.60 They believed that the formation of
huge banking conglomerates would benefit not only the U.S. financial services industry, but also the broader economy.61 Although GLBA advocates
understood that an unregulated marketplace had its risks, they believed that
the potential benefits of universal banking substantially outweighed the risks
that would accompany the formation of financial conglomerates.62
the largest U.S. bank holding company, to merge with Travelers, a major financial conglomerate that owned a leading securities firm, Salomon Smith Barney, as well as subsidiaries
engaged in a full range of insurance activities.” Id. “The FRB's approval of the Citigroup
merger placed great pressure on Congress to repeal the Glass-Steagall Act.” Id. at 972-73. A
conglomerate is “a corporation that owns unrelated enterprises in a wide variety of industries.” BLACK’S LAW DICTIONARY 253 (8th ed. 2004).
54. Banker, supra note 8, at 434.
55. Id.
56. Id. at 435.
57. Wilmarth, supra note 54, at 973. The repeal of Section 20 of the Glass-Steagall Act
gave commercial banks the ability to affiliate with firms that engaged in underwriting corporate securities. Id.
58. The Bank Holding Company Act of 1956, Pub. L. No. 511, 70 Stat. 133 (1956).
59. Wilmarth, supra note 54, at 973.
60. Zephyr Teachout, Break Up the Big Banks – Now, MICROSOFT MSN (Apr. 29, 2010,
6:50 PM), http://articles.moneycentral.msn.com/Investing/Extra/opinion-break-up-the-bigbanks-now.aspx.
61. Wilmarth, supra note 54, at 973.
The predicted benefits included (i) enabling financial holding companies to earn higher
profits based on favorable economies of scale and scope, (ii) allowing financial holding
companies to achieve greater safety by diversifying their activities, (iii) permitting financial holding companies to offer “one-stop shopping” for financial services, resulting
in increased convenience and lower costs for businesses and consumers, and (iv) enhancing the ability of U.S. financial institutions to compete with foreign universal
banks.
Id.
62. Id.
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Opponents of the GLBA argued that the provisions promulgated under the
GLBA would create financial risks and speculative excesses reminiscent of
the abuses that occurred during the 1920s.63 Many of the opponents even
predicted that removing the Glass-Steagall barriers would lead to a financial
calamity similar to the Great Depression.64 Nonetheless, following extensive
lobbying, public relations, and litigation campaigns by the banking industry,65 Congress was pressured into passing the GLBA.66
V.
The Era of Big Banking and Unprecedented Bailouts
Following the enactment of the GLBA, large diversified institutions began
to dominate the banking landscape.67 Goldman Sachs, Morgan Stanley,
Merrill Lynch, Lehman Brothers, and Bear Stearns formed huge holding
companies that engaged in a variety of risky banking activities on all sides of
the financial market.68 In an effort to make more money with less capital,69
these banks increased leverage70 and, as a result, inadvertently compounded
the risk that is part and parcel of a financial market devoid of regulatory
oversight.71 As risk continued to increase, banks were forced to design
mathematically sophisticated instruments to spread the risk.72 Unfortunately, the instruments proved to be inadequate substitutes for governmental
regulations, and the experience in laissez-faire economics would soon come
to a screeching halt.73
In September 2008, Lehman Brothers declared bankruptcy.74 Banks immediately froze credit.75 Toxic assets of questionable value were unable to
be traded on the market,76 and off-the-books subsidiaries of unknown value
63. Id.
64. Id.
65. Citicorp was the bank that the Federal Reserve Board allowed to merge with Travelers, the financial conglomerate that owned Salomon Smith Barney. Wilmarth, supra note 40,
at 972-73. These lawsuits put a great amount of pressure on Congress to enact the GLBA. Id.
66. Banker, supra note 8, at 435.
67. Id. at 437.
68. Richard B. Freeman, Reforming the United States; Economic Model After the Failure
of Unfettered Financial Capitalism, 85 CHI.-KENT L. REV. 685, 688 (2010).
69. Capital refers to “money or assets invested, or available for investment, in a business.” BLACK’S LAW DICTIONARY 172 (8th ed. 2004).
70. Leverage is the act of providing “a borrower or investor with credit or funds to improve speculative ability and to seek a high rate of return.” Id. at 758.
71. Freeman, supra note 69, at 689. Oversight of these banking transactions was at a
minimum “since no agency had jurisdiction over the full scope of bank transactions.” Id.
72. Id.
73. Id. at 692.
74. Id. at 692.
75. Freeman, supra note 69, at 692. A credit freeze refers to “a period when the government restricts bank-lending.” BLACK’S LAW DICTIONARY 553 (8th ed. 2004).
76. Freeman, supra note 69, at 692.
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and debt caused trepidation in the financial community.77 As the huge insurance firm American International Group (“AIG”) was about to crash, Congress passed the Troubled Assets Relief Program (“TARP”), which gave the
Treasury Department the authority to spend up to $700 million to stabilize
the financial market.78
The crisis brought an almost instantaneous recession to the United States
economy.79 The Obama Administration quickly responded by pushing an
economic stimulus bill through Congress.80 The American Recovery and
Reinvestment Act (“ARRA”) set up stimuli programs that were designed to
restore positive economic growth in the United States.81 Although the
TARP funds and the stimulus program alleviated some of the hysteria, the
financial sector and the U.S. economy remained on shaky ground.82
VI. The Dodd-Frank Wall Street Reform and Consumer Protection Act
In January 2010, President Obama called for Congress to pass sweeping
financial reform that would address the regulatory lapses that led to the financial crisis.83 He referred to the proposal as the Volcker Rule.84 The
President envisioned a bill that would ensure that no bank owned, invested
in, or sponsored a hedge fund, private equity fund, or proprietary trading
operation for its own profit.85
Congress responded by enacting the Dodd-Frank Wall Street Reform and
Consumer Protection Act.86 Dodd-Frank is by far the most comprehensive
and influential financial reform package since the Great Depression.87 It
contains several significant provisions that address the regulatory lapses that
contributed to the financial crisis.88 In particular, Dodd-Frank: (1) estab77. Id. at 693.
78. Id. The majority of the TARP money was used to establish eleven programs including “equity purchases, loans, and guarantees to aid for the auto industry and small businesses.” Id. “In its 2009 year-end report, the Congressional Oversight Panel concluded that
TARP helped stabilize financial markets and restore the flow of credit but warned that the
banking sector was still on shaky ground.” Id.
79. Freeman, supra note 69, at 694.
80. Id.
81. Id. at 694-95.
82. Id. at 695.
83. Barack Obama, U.S. President, Remarks by the President on Financial Reform, (Jan.
21, 2010, 11:34 AM), http://www.whitehouse.gov/the-press-office/remarks-presidentfinancial-reform.
84. Id. The Volcker Rule, named for the former Federal Reserve Chairman Paul Volcker,
refers to a provision in the bill that prohibits proprietary trading. Id.
85. Id.
86. 29 NO. 7 BANKING & FIN. SERVICES POLY REP., at 22.
87. Dodd-Frank Financial Reform Act Signed Into Law, FED. RESERVE BANK OF PHILA.
(Sept. 3, 2010), http://www.philadelphiafed.org/payment-cards-center/legislative-update/
2010/2q/.
88. Id.
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lished the Financial Stability Oversight Committee, which must monitor and
respond to threats that could jeopardize financial stability;89 (2) created the
Consumer Financial Protection Bureau to oversee the mortgage market and
credit card industry;90 (3) promulgated that derivatives91 must be traded
through a third-party clearinghouse and on regulated public exchanges;92 and
(4) gave the Federal Reserve the authority to liquidate failing financial institutions in an orderly fashion.93
ANALYSIS
I.
Is a Return to Glass-Steagall Practical?
In September 2009, in a statement before the House of Representatives,
Paul Volcker, the former Federal Reserve Chairman and one of President
Obama’s closest economic advisors, stated that he was in favor of restoring
the Glass-Steagall Act.94 Many other analysts and politicians, including U.S.
Senators John McCain and Maria Cantwell, have also stated that resurrecting
the Glass-Steagall Act was a favorable proposition.95 However, the real
question remains: Is the reinstatement of a modern-day Glass-Steagall Act
really practical, or is it merely a provocative ploy used by politicians to gain
support?
In September 2009, the American Bar Association published a report stating that the repeal of the Glass-Steagall Act was not responsible for the risky
investments that caused the financial crisis.96 The report stated that repealing the Glass-Steagall Act simply resulted in commercial banks affiliating
89. 29 NO. 7 BANKING & FIN. SERVICES POLY REP., at 22.
90. Dodd-Frank Financial Reform Act Signed Into Law, supra note 88.
91. A derivative is “a financial instrument whose value depends on or is derived from the
performance of a secondary source such as an underlying bond, currency, or commodity.”
BLACK’S LAW DICTIONARY 374 (8th ed. 2004).
92. Dodd-Frank Financial Reform Act Signed Into Law, supra note 88.
93. Id.
94. Statement by Paul A. Volcker Before the Committee on Banking and Financial Services of the House of Representatives, 2 (Sept. 24, 2009), http://media.ft.com/cms/db7fafe2a90b-11de-b8bd-00144feabdc0.pdf. Volcker stated that he “particularly welcome[d] the
strong reaffirmation of one long-standing principal—the separation of banking from commerce—that has long characterized the American approach toward financial regulation.” Id.
95. Alison Vekshin, U.S. Senators Propose Reinstating Glass-Steagall Act, BLOOMBERG
(Dec. 16, 2009, 4:24 PM), http://www.bloomberg.com/apps/news?pid=ewsarchivesid=
QfRyxBZs5uc. See also Bonnie Erbe, For Financial Reform, Reinstate Glass-Steagall Act,
U.S. NEWS & WORLD REPORT (May 12, 2010), http://politics.usnews.com/opinion/blogs/
erbe/2010/5/12/For-Financial-Reform-Reinstate-Glass-Steagall-Act.html.
96. American Bar Association Banking Law Committee/Task Force on the Causes of the
Financial Crisis, The Financial Crisis of 2007-2009: Causes and Contributing Circumstances, 32 (Sept. 2009), http://www.abanet.org/buslaw/committees/CL130055pub/
materials/201001/causes-report.pdf.
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with entities engaged in underwriting corporate securities.97 It was not responsible, however, for the risky lending practices and weak credit underwriting standards that led to the financial crisis.98 Those commercial banking practices were permitted long before the enactment of the GLBA.99
Daniel Indiviglio of The Atlantic has corroborated this viewpoint.100 Indiviglio insists that leaving the Glass-Steagall Act intact would not have prevented the financial crisis because the risky securities that caused the financial crisis were not the securities that the GLBA permitted, but rather, they
were bonds backed by real estate, which originated in commercial banks.101
He believes that if securitization of these mortgage-backed bonds never existed, the commercial banking sector would be in shambles right now.102
Robert Pozen of Forbes Magazine also agrees the assertion that the repeal
of the Glass-Steagall Act was a minor factor leading up to the financial crisis.103 With the exception of underwriting corporate stocks and bonds,
commercial banks were allowed to participate in the same investment activities before and after the repeal of the Glass-Steagall Act.104 It is true that
banks increasingly engaged in underwriting mortgage-backed securities following the enactment of the GLBA, but big banks only held the highest
rated mortgages, just as they had done prior to the repeal of the GlassSteagall Act.105
It follows from these assessments that the repeal of the Glass-Steagall Act
did not contribute to the financial crisis of 2008. Why then have so many
politicians and analysts called for the enactment of a modern-day GlassSteagall Act if it would not prevent the predatory lending practices or the
dealing of mortgage-backed securities that caused the financial crisis of
2008? The reason lies in the fact that the repeal of Section 20 of the GlassSteagall Act not only lifted the prohibition of underwriting corporate securities, but it also permitted affiliation between separate financial entities. The
repeal of this Glass-Steagall provision, along with the amendment of the
Bank Holding Company Act, created the impetus for banks to consolidate
97. Id.
98. Id.
99. Id.
100. Daniel Indiviglio, Volcker’s Quest to Reinstate Glass-Steagall, ATLANTIC (Oct. 21,
2009), http://www.theatlantic.com/business/archive/2009/10/volckers-quest-to-reinstate-glasssteagall/28759/.
101. Id.
102. Id.
103. Robert Pozen, Stop Pining for Glass-Steagall, FORBES (Oct. 5, 2009, 6:00 PM),
http://www.forbes.com/forbes/2009/1005/opinions-glass-steagall-on-my-mind.html.
104. Id. Pozen stated that even before the repeal of the Glass-Steagall Act, “commercial
banks could invest in bonds, manage mutual funds, execute trades on the order of their customers and underwrite governmental-related securities.” Id.
105. Id.
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into large, diversified institutions that became known as too-big-to-fail
(TBTFs)106 during the financial crisis of 2008.
II.
Too-Big-To-Fail Banks
A.
The Dangers Associated with Too-Big-To-Fail Banks and Government
Bailouts
Absent from many of the assessments regarding the financial crisis of
2008 is the fact that the creation of TBTFs have produced a plethora of problems for the economy and the American people. Although many other factors contributed to the financial crisis of 2008,107 it is undeniable that TBTFs
have changed the manner in which the banking industry has operated over
the past ten years.
The primary argument against TBTFs is that they create moral hazard.108
Moral hazard posits that an entity insulated from risk will act differently than
it would if it was fully exposed to risk.109 In a practical sense, this means
that banks have no incentive to avoid risky investment practices because of
an implicit government guarantee against failure.110 This theory explains
why banks were so eager to consolidate following the enactment of the
GLBA. They strived to become financial behemoths that were so large and
interconnected that the government would be forced to bail them out when
they failed.
Although moral hazard is an inherently dangerous characteristic of
TBTFs, the true perils that accompany TBTFs materialize once there is a
government bailout. There are three arguments against government bailouts.
First, a bailout harms ordinary Americans by forcing them to foot the bill for
mistakes made by either politicians or bankers.111 Secondly, bailouts undermine market discipline because big banks no longer have an incentive to
106. “‘Too Big To Fail’ (“TBTFs”) are those [financial institutions] whose insolvency
could shake the foundations of the U.S. financial system and our economy.” Graham, supra
note 10, at 118.
107. Certain factors that are believed to have caused the financial crisis include:
Federal Reserve interest rate policy (keeping interest rates low for so long that excess
liquidity in our economy contributed to a real estate bubble); unregulated mortgage
originators and poor loan underwriting standards; industry compensation policies*128
that encouraged excessive risk-taking; securitization of loans that removed the balance
sheet risk of loan default from the originator; complex unregulated derivative securities;
and counter-party risk.
Id. at 127-28.
108. Id. at 128.
109. Moral Hazard is “the lack of any incentive to guard against a risk when you are protected against it (as by insurance).” THE FREE DICTIONARY, http://www.thefreedictionary.com/moral+hazard (last visited Oct. 25, 2010).
110. Graham, supra note 10, at 128.
111. Id. at 124.
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Dodd-Frank Reform and Consumer Protection Act
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engage in sound risk management.112 Thirdly, bailouts substantiate the belief that banks will be bailed out when they fail, which, in turn, creates more
moral hazard.113 The end result obviously is anger towards greedy businessmen on Wall Street, and distrust towards politicians who consistently
fail to change the manner in which government functions.
These dangers explain why TBTFs must be reduced in order to avoid another future economic calamity. Ann Graham of Texas Tech University
School of Law has proposed a manner in which this can be accomplished.114
She claims that the first step in this direction would be a clear, unequivocal
statement from the government that TBTFs will no longer be bailed out by
the government.115 This would eliminate the problems associated with moral
hazard and weakened market discipline discussed above. Once this proclamation is made, Congress would have the opportunity to enact several substantial pieces of legislation that would be able to transform the economic
landscape including: (1) prohibiting bailouts; (2) penalizations for regulators
that provide bailouts; and (3) appointing regulators who have the fortitude to
resist bailouts.116 With these solutions waiting in the wings, it seems that the
financial crisis of 2008 serendipitously presented an opportunity for Congress to enact certain laws that would transform the economic landscape.
B.
The Financial Crisis of 2008
No one can fault the Bush Administration for acting swiftly to bail out the
banking industry when it appeared to be on the verge of collapse. TARP
was necessary to avert an economic meltdown by relieving banks of their
112. Id.
113. Id.
114. Id. at 154.
115. Graham, supra note 10, at 151.
116. Id. at 152-54. Professor Graham has also suggested that future research should explore mechanisms to:
1. Initiate size caps that limit continued expansion of financial conglomerates through
internal growth and acquisitions.
2. End government-assisted acquisitions that allow the largest institutions to grow even
larger--at public expense.
3. Reinstate true firewalls between banking and commerce.
4. Return to meaningful antitrust enforcement.
5. Immediately initiate reform measures such as increased capital for large institutions,
subordinated debt requirements that enhance market discipline, enhanced systemic risk
monitoring and regulation, and better advance planning for liquidating large complex
financial institutions.
6. As a longer term measure, commission a carefully researched report on how to most
effectively divide the existing conglomerates into manageable component parts that
will no longer be Too Big To Fail.
Id. at 154-55.
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most poisonous assets.117 TARP funds were given to some of the largest
financial institutions including Bear Stearns,118 American International
Group,119 Freddie Mae and Fannie Mac,120 Wachovia,121 Merrill Lynch,122
and Citigroup.123 Although these funds were intended to buy up toxic assets124 and help expand the flow of credit,125 many of the largest banks used
this money for bonuses,126 or to fund takeovers of smaller ailing banks.127
In 2009, after the smoke cleared and the dust settled, financial analysts,
along with the American people, began to call for an end to TBTF banking
institutions.128 It seemed as though President Obama concurred with this
national sentiment from the remarks he made during his speech in January
2010.129
In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law.130 To be fair, it contains many good provisions. For example, the Consumer Financial Protection Bureau will benefit
borrowers by protecting them from many of the abusive lending practices
117. Scott Lanman & Timothy R. Homan, Bernanke Says Fed sought to Avert a ‘Second
Great Depression,’ BLOOMBERG (June 27, 2009 12:01 AM), http://www.bloomberg.com/
apps/news?pid=newsarchive&sid=aUYcp6zduGx0.
118. Bears Stearns was an investment bank that was “purchased by JP Morgan Chase in a
federally brokered transaction.” Graham, supra note 10, at 119.
119. American International Group was an insurance conglomerate that “received $85
billion in exchange for government ownership of 79.9% equity stake.” Id.
120. Fannie Mae and Freddie Mac were Government Sponsored Entities that were “placed
in conservatorship by the Federal Housing Finance Agency.” Id.
121. At one time, Wachovia was the fourth-largest bank. Id. at 120. It was “heavily involved in subprime lending [and eventually was] purchased by Wells Fargo.” Id.
122. Merrill Lynch was an investment bank that was acquired by Bank of America. Graham, supra note 10, at 120.
123. Id. at 119-20.
124. Toxic assets, also known as illiquid assets, are assets “that [are] not readily convertible into cash, usually because of (1) the lack of demand, (2) the absence of an established
market, or (3) the substantial cost or time required for liquidation (such as for real property,
even when it is desirable).” BLACK’S LAW DICTIONARY 96 (8th ed. 2004).
125. Freeman, supra note 69, at 693.
126. Henry Blodget, 75% of Latest Bank of America Bailout Used to Pay Merrill Lynch
Bonuses (BAC), BUSINESS INSIDER (Jan. 22, 2009, 6:22 AM), http://www.businessinsider.com
/2009/1/75-of-latest-bank-of-america-bailout-paid-merrill-lynch-bonuses-bac.
127. Paul Kiel, Banks to Use Bailout Bucks for Mergers, PROPUBLICA, (Oct. 27, 2008,
11:25 AM), http://www.propublica.org/article/banks-signal-govt-billions-will-be-used-formergers-1027.
128. Dean Baker, Why We Must Break Up the Banks, GUARDIAN, (Apr. 7, 2010, 5:30 PM)
http://www.guardian.co.uk/commentisfree/cifamerica/2010/apr/07/paul-krugman-break-upbanks. See also Teachout, supra note 61.
129. Obama, supra note 84. President Obama stated that he wanted “to prevent the further
consolidation of [the] financial banking system,” and that “the American people will not be
served by a financial system that comprises just a few massive firms.” Id.
130. 29 NO. 7 BANKING & FIN. SERVICES POLY REP., at 22.
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that caused the financial crisis.131 It also increases oversight in the derivatives market by forcing swaps132 to be exchanged, traded, or passed through
clearinghouses.133 With regard to TBTFs, however, it left much to be desired.
What began as a hopeful “Volcker Rule” piece of legislation ended with a
watered-down bill tailored to the fat-cats on Wall Street. Dodd-Frank completely ignored the underlying problems posed by TBTFs. Instead of enacting a substantial law that would disintegrate TBTFs, reform Wall Street, and
end the government’s role as insurer, Congress once again succumbed to the
pressure applied to them by bank lobbyists and refused to interfere with the
manner in which TBTFs operated. Unfortunately for the American people,
it seems that Senator Bernie Sanders was the only person in Congress who
recognized that a bank that is too big to fail is too big to exist. 134
CONCLUSION
During the Great Depression, President Roosevelt stated that almost all
significant laws occur during times of crisis.135 In his January 2010 speech,
President Obama seemed to acknowledge this aphorism when he stated that
American taxpayers would never again be held hostage by the fat-cats on
Wall Street.136 However, a bill that began with so much potential ended as
another example of how “business as usual” operates in Washington.
Dodd-Frank failed to take into account the underlying problems that
TBTFs pose to the economy. As a result, it is inevitable that another economic catastrophe will occur in the future. The bailout has created a banking atmosphere that is saturated with moral hazard, and devoid of market
discipline. Although the bailout may have been necessary to prevent an
economic meltdown in the short run, it has substantiated the belief that the
government is indeed the insurer of banks that are too large and interconnected to fail.
131. Id. at 23-24. The Bureau of Consumer Financial Protection was created to “regulate
all providers – bank and nonbank – of consumer financial products and services. Dodd-Frank
Financial Reform Act Signed Into Law, supra note 88.
132. A swap is “an exchange of one security for another.” BLACK’S LAW DICTIONARY 1213
(8th ed. 2004).
133. Dodd-Frank Financial Reform Act Signed Into Law, supra note 64.
134. Bernie Sanders, Too Big to Fail – Too Big to Exist, HUFFINGTON POST (Nov. 6, 2009, 9:41
AM), http://www.huffingtonpost.com/rep-bernie-sanders/too-big-to-fail---too-big_b_348251.html.
135. Graham, supra note 10, at 150.
136. Obama, supra note 84.