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Behind every financial crisis lurks a \"political bubble\"--policy biases that foster market behaviors leading to financial instability. Rather than tilting against risky behavior, political bubbles--arising from a potent combination of beliefs, institutions, and interests--aid, abet, and amplify risk. Demonstrating how political bubbles helped create the real estate-generated financial bubble and the 2008 financial crisis, this book argues that similar government oversights in the aftermath of the crisis undermined Washington's response to the \"popped\" financial bubble, and shows how such patterns have occurred repeatedly throughout US history. The authors show that just as financial bubbles are an unfortunate mix of mistaken beliefs, market imperfections, and greed, political bubbles are the product of rigid ideologies, unresponsive and ineffective government institutions, and special interests. Financial market innovations--including adjustable-rate mortgages, mortgage-backed securities, and credit default swaps--become subject to legislated leniency and regulatory failure, increasing hazardous practices. The authors shed important light on the politics that blinds regulators to the economic weaknesses that create the conditions for economic bubbles and recommend simple, focused rules that should help avoid such crises in the future. The first full accounting of how politics produces financial ruptures,Political Bubblesoffers timely lessons that all sectors would do well to heed.

This paper is a discussion of monetary efficiency, monetary safety, and the relation of the 1933 Glass-Steagall Act to both. It contains speculation about whether a modified version of the Act could have postponed or prevented the crisis of 2008.

The banking legislation of the 1930s took very little time to pass, was unusually comprehensive, and unusually responsive to public opinion. Ironically, the primary motivations for the main bank regulatory reforms in the 1930s (Regulation Q, the separation of investment banking from commercial banking, and the creation of federal deposit insurance) were to preserve and enhance two of the most disastrous policies that contributed to the severity and depth of the Great Depression—unit banking and the real bills doctrine. Other regulatory changes, affecting the allocation of power between the Federal Reserve System (Fed) and the Treasury, were intended to reduce the independence of the Fed, while giving the opposite impression. Banking reforms in the 1930s had significant negative consequences for the future of US banking, and took a long time to disappear. The overarching lesson is that the aftermath of crises are moments of high risk in public policy.

Public policy has been focused on controlling the conflicts of interests in banks for the last eighty-five years with limited success. Banks have a unique place in the economy as intermediaries between investors and companies, allowing them to obtain significant private, proprietary information. Public policy is focused on trying to ensure that banks do not misuse this information for their own benefit to the detriment of their clients. This is a tough task. In this Article, we focus our attention more specifically on proprietary trading. We exploit a unique dataset that allows us to observe the information banks receive and what they do with it. When banks are hired as investment advisers, they become temporary insiders, and they are required to report all transactions in their client firms' stock to the SEC. Using this unique dataset, we analyze the kind of information banks acquire about their clients as part of their financial intermediary and advisory roles. Our data show that this information is highly valuable to banks. Specifically, banks have been able to earn more than 25% returns above market from proprietary trades on this information. Furthermore, after Glass-Steagall's prohibitions against commercial banks engaging in investment banking activities were relaxed, this return on investment rose to a whopping 40%. The Volcker Rule was enacted to aid in reducing systemic risks in the banking system and, among other purposes, to eliminate conflicts of interest that arise when banks profit at the expense of their clients. Scholars have previously argued that the Volcker Rule should be vigorously enforced to eliminate temptations to trade on material non-public information for banks ' benefit and against their client 's interest. We provide important empirical research for this proposition by showing that banks indeed trade on non-public information and earn higher than expected returns.

Enactment of the Gramm-Leach-Bliley Act (GLBA) in November 1999 effectively repealed the long-standing prohibitions on the mixing of banking with securities or insurance businesses and thus permits “broad banking.” We attribute repeal of these prohibitions to the increasingly persuasive evidence from academic studies of the pre-Glass-Steagall era, the recent favorable experience in the United States following partial deregulation of banking activities, the experience of banking systems abroad with broader scopes for banking activities, and rapid technological change in telecommunications and data processing. How regulators will in practice coordinate their efforts so that the safety and soundness of the banking system is maintained efficiently remains to be seen.

The Glass-Steagall Act was passed in 1933 in response to the failure of the banks following the Great Depression. One out of every five banks failed in the aftermath of the stock market crash. Legislators and regulators questioned the role the underwriting of securities played in the financial collapse. Many believed these investment banking activities caused a conflict of interest in that banks often suggested that their customers purchase securities the banks had underwritten. They believed that this conflict of interest contributed significantly to the stock market crash and the bank failures. The Glass-Steagall Act forced banks to choose between being a commercial bank or an investment bank, in effect constructing a wall between commercial banking and investing banking activities. The Glass- Steagall Act was the first law signed by President Franklin D. Roosevelt upon taking the oath of office. Almost immediately upon enactment, the financial community lobbied to have the Act repealed. Over the years, this persistent lobbying led to a continual reinterpretation and liberalization of the Glass-Steagall Act, until the Act was repealed in 1999. On the dawn of repeal, the late Senator Paul Wellstone made an impassioned plea on the Senate floor. He said the repeal of Glass-Steagall would enable the creation of financial conglomerates which would be too big to fail. Furthermore, he believed that the regulatory structure would not be able to monitor the activities of these financial conglomerates and they would eventually fail due to engaging in excessively risky financial transactions. Ultimately, he said, prophetically, that the taxpayers would be forced to bail out these too-big-to-fail financial institutions. Clearly, Senator Wellstone was in the minority as the legislation repealing the Glass-Steagall Act was passed in both the House and the Senate with large majorities. President Bill Clinton signed the legislation into law in late November, 1999. It has now been over ten years since the repeal of Glass-Steagall and the United States is in the grip of the largest financial crisis since the Great Depression. Legislators and regulators are again questioning the role that the investment banking activities of commercial banks have played in a financial crisis. Some believe the repeal of Glass-Steagall contributed significantly to the current financial crisis. Others believe that if Glass-Steagall had still been in place, the financial crisis would be much worse. This paper examines the role that the repeal of Glass-Steagall played in the current financial crisis.

Few would disagree that the Glass-Steagall Act of 1933 is the continental divide in American financial and banking history. By disallowing banks from getting involved in the investment banking industry, this Act imposed an institutional change that shaped how financial institutions conduct their business, even today in its decline. Conventional wisdom has it that the Act was enacted to correct the \"deficient\" financial system that existed during the period. In this paper we investigate whether this assertion can be empirically verified by analyzing the Senate vote on a predecessor of this Act (which included the clause separating commercial banking from investment banking activities). Using multinomial logits, we examine what may have motivated senators to vote for its passage. The econometric evidence indicates that the Senate vote was significantly influenced by important interest groups (including national banks as well as manufacturing sector interests), despite the large populist outcry for financial market reforms at the onset of the Depression.

With the Senate race as yet undecided, the US regulatory system could be set for deadlock as it faces Republican resistance to change

The introduction of the bill coincides with a House Financial Services Committee hearing with seven big bank leaders.