False Nostalgia

Stress Test Doesn't Cry Out for Glass-Steagall

A funny thing happened on the way back to 1930s bank regulation.
Photographer: Bloomberg
As of 3:54 PM EDT
236.16 USD
As of 3:54 PM EDT
69.30 USD

The need to bring back Glass-Steagall, the Depression-era rule that kept commercial banks out of the investment business, is one of the few policy proposals that has found broad political support.

Senator Bernie Sanders is for it. As is, at times, President Donald Trump. Trump adviser Gary Cohn said in early April that he generally supported going back to the days when his old firm Goldman Sachs Group Inc. was just an investment bank and big banks like Citigroup Inc. stuck to lending. Senators Elizabeth Warren and John McCain back a bill to institute a so-called 21st-century Glass-Steagall.

Close Call

All of the banks passed the Fed's annual stress test, but Goldman Sachs and Morgan Stanley came the closest to the 3 percent pass-fail line on a key measurement

Source: Federal Reserve

But a look at the stress-test results this week suggest bringing back banking regulations circa 1930s would make the risk of bailouts bigger, not banished.

Nearly all of the nation's biggest banks passed the final round of the annual stress test on Wednesday. They're all increasing their dividends. Capital One was told to resubmit, but that likely has more to do about fears about credit card lending than a potential financial crisis.

But the banks that did the worst on the test were not the big integrated ones, like JPMorgan Chase & Co., that Glass-Steagall would leave most busted up, but rather the stand-alone investment banks. In fact, the worst-performing bank, at least on one key metric, was Goldman. Its supplementary leverage ratio, after factoring in proposed dividends and stock buybacks, as well as losses in the stress test, dropped to 3.1 percent. That was the lowest of all the big banks and just a hair above 3 percent, which is arguably too low -- roughly measuring how much money a bank has left to cover soured loans or bad trades -- but that's the pass-fail line. The second-worst performer of the big banks was Morgan Stanley, which has dipped its wingtip into lending in the past few years but is still primarily, like Goldman, an investment bank. It's SLR ratio was just slightly higher at 3.2 percent.

The ones that now straddle the Glass-Steagall line the most did better. Citigroup, Bank of America Corp. and JPMorgan had SLRs of 4.5 percent, 4.3 percent and 3.9 percent, respectively. That being said, Wells Fargo, which still derives most of its revenue from traditional lending, did fine as well. It had the highest SLR of 5.3 percent.

Nonetheless, the stress test seems to back up what JPMorgan CEO Jamie Dimon has said for a while, that his bank is less at risk of running into a financial crisis type-problem as a larger diversified organization than its pieces would be broken up. And remember in the financial crisis, it wasn't the diversified banks that ran into the biggest problems, though Citigroup and Bank of America were surely stressed. The big banks that failed or would have if they hadn't been acquired -- Bear Stearns Cos., Lehman Brothers Holdings Inc., Merrill Lynch and Wachovia Corp. -- were primarily in the investment business for the first three and lending for Wachovia, but not both.

Glass-Steagall is a nice political talking point probably because it's nostalgic and sounds logical. But while going back to the days when banks were just banks may satisfy our "keep it simple, stupid" urges, it's not clear, at least from this week's stress-test results, it would make the financial system any safer.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Stephen Gandel in New York at sgandel2@bloomberg.net

    To contact the editor responsible for this story:
    Daniel Niemi at dniemi1@bloomberg.net

    Before it's here, it's on the Bloomberg Terminal.