Financial History 143 Fall 2022 - Page 37

President Barack Obama signs the Dodd-Frank Wall Street Reform and Consumer Protection Act alongside members of Congress and the administration including Connecticut Democrat Senator Chris Dodd ( C ), Massachusetts Democrat Representative Barney Frank ( 2nd R ), Speaker of the House Nancy Pelosi ( 2nd L ) and US Vice President Joe Biden ( L ), at the Ronald Reagan Building in Washington , DC , July 21 , 2010 .
The easy-money policies adopted by central banks during the Great Recession and the pandemic crisis facilitated huge increases in global private-sector and public-sector debts . Between 2007 and 2021 , worldwide private-sector and public-sector debts nearly doubled from $ 167 trillion to $ 303 trillion . During the same period , the ratio of total worldwide debts to global GDP rose from 275 % to 351 %. In 2021 , worldwide government debts reached their highest levels since World War II as a percentage of global GDP .
It became clear in 2022 that massive deficit spending by governments and prolonged monetary stimulus by central banks contributed to two major global threats . First , many countries experienced their highest inflation rates in four decades , and their central banks struggled to bring inflation under control without triggering severe economic contractions . Second , many heavily-indebted nations confronted actual or potential debt crises . Rising default rates on sovereign and private-sector obligations threatened to unleash a series of debtrelated panics , especially in countries with large amounts of borrowings denominated in dollars and other foreign currencies .
The Benefits Offered by a New Glass-Steagall Act
The pandemic crisis and its aftermath have highlighted our failure to address the fundamental causes of the global financial crisis of 2007-09 . Despite post-crisis reforms , the world remains trapped in an infernal cycle of unsustainable booms — financed by universal banks and shadow banks — followed by destructive busts that governments and central banks must attempt to “ contain ” through huge bailouts . In view of the enormous debt burdens carried by most governments , it is very doubtful whether they could finance another round of bailouts comparable to the rescues they arranged in 2007 – 09 and 2020 – 21 . If governments and central banks fail to “ contain ” the next systemic crisis , the world could fall into a second Great Depression .
Congress must adopt a new Glass-Steagall Act to end the destructive boom-andbust cycles of the past three decades . A new Glass-Steagall Act would separate banks from the capital markets , thereby preventing banks from using government-backed deposits to finance speculative underwriting and trading activities . Banks would return to their traditional roles as providers of deposit , lending , payment and fiduciary services . In addition , a new Glass-Steagall Act would prohibit non-banks from offering short-term financial instruments that function as deposit substitutes , such as money market mutual funds , commercial paper , repos and digital stablecoins .
A new Glass-Steagall Act would greatly improve the stability and resilience of our
financial system . It would reestablish risk buffers that prevent crises from spreading across financial sectors . It would improve market discipline by stopping banks from transferring their government subsidies to affiliates engaged in securities and other capital market activities . The federal government would no longer be forced to bail out the entire financial system to keep large banks from failing due to their capital market operations . Shadow banks would shrink significantly , as they could no longer fund their operations with short-term financial instruments .
A new Glass-Steagall Act would create a more diverse and competitive banking system by breaking up universal banks . It would enable bank regulators to monitor and control levels of short-term claims in financial markets because those claims could be issued only by banks . Large banks would have much stronger incentives to serve all segments of business and society — including consumers and Main Street businesses that lack access to the capital markets — instead of focusing their efforts on Wall Street speculators , multinational corporations and wealthy investors .
Securities markets would again become true markets because they would no longer be bailed out to protect universal banks and large shadow banks . Our political , regulatory and monetary policies would no longer be held hostage to the interests of giant financial conglomerates . Banks , securities firms , insurance companies and asset managers would return to their proper roles as servants — not masters — of commerce , industry and society .
In 1914 , Louis Brandeis warned the American public , “ We must break the Money Trust or the Money Trust will break us .” In 1933 , Congress acted on his admonition by passing the Glass-Steagall Act . Brandeis ’ warning is as relevant today as it was in 1914 and 1933 .
Art Wilmarth is a Professor Emeritus of Law at George Washington University Law School in Washington , DC . This essay is based on his book , Taming the Megabanks : Why We Need a New Glass-Steagall Act ( Oxford University Press , 2020 ), and his article , “ Afterword : Why ‘ Taming the Megabanks ’ Should Remain a Top Priority for Financial Regulators and Policymakers ,” 93 University of Colorado Law Review 1061 – 94 ( 2022 ).
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