The irrelevance of Glass-Steagall II

Arkady explains why the Volcker Rule is inadequate:

This topic may sound mundane, but understanding the history behind this controversial act is important to absorb as talks about it’s reinstatement heat up. Glass-Steagall was repealed in 1999 by the Gramm-Lichey-Bliley act and has been blamed by many as the primary cause of the 2008 Housing Crisis. Recently John McCain and ex-Fed chairman Paul Volcker proposed the return of Glass-Steagall along with many Democrats and prominent bloggers including Karl Denninger of Market Ticker fame. However without examining the history of Glass-Steagall and the cause of its existence can lead to needless legislation and shift the conversation away from the true root cause of our financial system.

It’s a good article. While there is no question that the rollback of Glass-Steagall exacerbated the ongoing financial crisis, it clearly was not and could not be the root of the problem, as the global scope of the crisis clearly proves. The problems in Greece, Portugal, Spain, and Dubai cannot be traced to Washington. That doesn’t mean it’s not a good idea to prevent the banks from digging themselves into even deeper holes, but it is essentially a sideshow.

The real problem, as Arkady points out, is the increasingly creaky Federal Reserve System, which will eventually fail on the basis of its structural dependency on ever-increasing debt.

The Baseline Scenario likewise concludes that the Volcker Rule is insufficient:

I testified yesterday to the Senate Banking Committee hearing on the “Volcker Rules”. My view is that while the principles behind these proposed rules are exactly on target – limiting the size of our largest banks and preventing any financial institution backed by the government, implicitly or explicitly, from taking big risks – the specific rule changes would need to be much tougher if they are to have any effect.

As events should demonstrate reasonably soon, all of the finagling over petty details will likely be rendered meaningless by the tidal wave of debt-deflation. One really big default will be enough to set off the panic; the recent market retreat is a sign that the investing class is beginning to realize that the reflation strategy has failed.