How to prevent another Wells Fargo type scandal

October 12, 2016 by Matt McCracken

Two words:  Glass-Steagall.  

I admit it, I am an unabashed Glass-Steagall apologist.  I think it would go a long way to solving a great number of our nation's problems, especially the financial ones.  Consider its success.  During the enforcement of Glass-Steagall, our nation operated sans banking crisis for nearly 70 years.  Outside of the Savings and Loan crisis which proved to have a minimal macro impact, there was not a single banking-centric recession in nearly two generations.  

Of course, Glass-Steagall is repealed in December of 1999 and BAM, stock market declines 50% while companies like Enron implode.  Would Enron have happened without the banks assistance?  Absolutely not, as the banks had to provide the financing for their shell entities which were trading their assets which allowed them to ever increase their value using "mark-to-market" accounting.  

Then seven years later, the housing market burst which was almost entirely a banking sector creation.  Would Glass-Steagall prevented it - it would have absolutely reduced its impact as investment banks would have never bought up worthless mortgages from the lending banks except for the fact that the lending banks were under the same roof.  Without a market for crappy mortgages, the lending banks would have had to hold them on their books and I certainly believe underwriting standards would have been a bit stricter.  But the investment banks were also doing the lending so they had to buy the crappy mortgages, securitize them and sell them off as quickly as they could.  Certainly, some investment bank would have blown the whistle on the whole thing had they not all been making so much money off of the same scheme.

My arguement is that Glass-Steagall results in banks policing themselves.    Wells had been conducting its own internal investigation of the matter since 2011.  Here we are five years later and its just now coming to a head.  Countless customer complaints over the past several years led to no resolution until now.  But if Glass-Steagall was in place and investment banking firms got wind of these practices, certainly, someone would have brought it to the market's attention.  But without barries between lending and investment banking, who is going to "blow the whistle" knowing their own company is probably doing something similar.  

Government bureaucracies will never be able to properly regulate the banking sector.  NEVER!  The only effective form of regulation is for the banks to police themselves.  And the only means of creating this environment is to seperate their activities.  This incentivizes them to basically "taddle" on one another.  As soon as a bank starts making copious amounts of money doing something shady, a different type of banking company who is not allowed to do said shady activity and therefore is prohibited from making copious amounts of money doing said shady activity, will taddle on the wrong-doer.  It worked for nearly 70 years.    

So until Glass-Steagall is reinstated, don't be surprised if more of these types of shananigans continue.  The good news is, there is an election coming up and while neither of the candidates of the major parties is willing to reinstate Glass-Steagall, some others are.  And they deserve our attention.