The High Cost of Cheap Money

What is a bank? How does a bank work? 

You’d think that these would be obvious and easily answered questions, especially now that everybody with a byline is a five-minute expert on Silicon Valley Bank. (My editors have just informed me that The Dispatch was an SVB customer and would like that noted in the interest of full disclosure, which, now, it has been.) But, as usual, it is a little more complicated than the politicians would have you believe.

For years, we’ve heard progressive (and sometimes right-wing populist) politicians and their media friends insist that the 2007-08 financial crisis could have been avoided if not for the 1999 repeal of the Glass-Steagall Act, a package of Depression-era banking regulations that, among other things, created the FDIC. That claim is, and always has been, almost complete poppycock. Glass-Steagall regulated the affairs of commercial banks—meaning the kind of bank where regular people open checking and savings accounts, take out personal loans, etc. But the firms that were at the center of the 2007-08 financial crisis were a different kind of creature entirely: They were mostly pure-play investment banks, which are financial institutions that provide services to big corporate and institutional customers, which do not have regular-Joe depositors and whose activities are not insured by the FDIC, which doesn’t insure investments, only deposits. Bear Stearns and Lehman Brothers were investment banks; AIG was an insurance company and diversified financial-services conglomerate; Morgan Stanley and Goldman Sachs were investment banks that became commercial banks as part of the Federal Reserve’s stabilization efforts, and Goldman insists that it never needed a bailout but wasn’t going to forgo the offer of nearly free federal money; etc. The repeal of Glass-Steagall meant that investment banks and commercial banks could, to an extent, get into one another’s businesses, but that wasn’t much of a factor in the 2007-08 financial crisis. A number of FDIC-insured banks did fail in those years—nearly 500 between 2008 and 2013, mostly small institutions you’ve never heard of, but not for reasons that would have been prevented by Glass-Steagall. 

Almost nobody in Washington really wants to understand this stuff—they want someone to blame and a policy narrative that fixes such blame in a persuasive way. Political stories are fairy tales, and fairy tales need villains. There was plenty of bad behavior, wishful thinking, short-termism, and self-dealing leading up to the 2007-08 financial crisis, and plenty of bad policy decisions that contributed to it—starting in the 1930s and continuing under presidencies and Congresses controlled by both parties. But the basic true facts of the case don’t offer much in the way of a satisfying moral zing or a black-hats/white-hats narrative, because what happened is that a bunch of investors made a bunch of bad investment decisions, which normally wouldn’t be that big of a deal except for the fact that so many of them had, for a variety of policy and business-practice reasons, made the same bad investment decision.