Is it not true that repeal of the Glass Steagall contribute to the financial crisis?
Russ Roberts: I want to start with a very interesting point you make about the repeal of Glass-Steagall. Now, a lot of people blame the crisis on the repeal of Glass-Steagall and the Gramm-Leach-Bliley Act, accomplished that in 1999. It was a Democratic president who signed that but I think it was a Republican Congress that pushed it; but it was a bipartisan bill. It got a lot of support from both sides of the aisle. And you make the argument that its direct effect in causing the crisis was very small. So I want you to explain that. And then the more interesting point--but you still point out the political implications of that were not small. That's fascinating. So, talk about those two things. First, why it had little direct impact but its political impact was not trivial.
Luigi Zingales: So, just to make sure that everybody is on board, I think that what Glass-Steagall used to do is to separate commercial banks from investment banks. And during the crisis, the banks that were most exposed and suffered the most and some of them failed to be bailed out were pure investment banks that would have existed even before the repeal of Glass-Steagall and would have got in trouble even before the repeal of Glass-Steagall. And in fact, one of the solutions or partial solutions to this crisis was to have some rescues, so you had J.P. Morgan buying Bear Stearns, and you had Bank of America buying Merrill Lynch, and this was made possible by the repeal of Glass-Steagall. Because during Glass-Steagall JPMorgan could not have bought Bear Stearns and Bank of America could not have bought Merrill Lynch. The only sort of bad example in this picture was Citigroup. Citigroup was both an investment bank and a commercial bank, and it was highly exposed and was really saved by the government because otherwise it would have gone bust. And by the way, during the crisis, the way you got some confidence back for banks like Morgan Stanley and Goldman Sachs was for them to file as commercial banks. So, I think there is no question; in my view, the separation of investment banking and commercial banking was not the [?] factor in causing the crisis or precipitating the crisis.
Russ: Did you mean to say that without Glass-Steagall, that if Glass-Steagall were still in place, that JPMorgan could not have purchased Bear Stearns?
Guest: Yeah. It could not. Because it was an investment bank.
Russ: Aren't they both investment banks?
Guest: JPMorgan is a commercial bank. JPMorgan Chase is actually both, a huge commercial franchise.
Russ: Okay. I get the point, then. The argument
for Glass-Steagall of course is that commercial banks are FDIC insured, and the story is that if you merged them the money would somehow get mixed together and that made the investment banks that had commercial arms or vice versa too big to fail. But the truth is, the investment banks were viewed as implicitly insured anyway. So, it's in a way it does seem to be not a very important piece of legislation, the repeal of it.
Guest: In addition, the investment banks were heavily exposed to commercial banks through sort of a lot of loans. If an investment bank had failed, probably would have brought down the commercial banks that guaranteed the credit. So, the separation itself I don't think is the most effective way to limit risk.
