One of the most pernicious myths to emerge from the Great Financial Crisis is the myth had the Glass-Steagall Act separating commercial and investment banking not been repealed we wouldn’t have had a crisis.  It seldom happens, but I agree with Ben Bernanke.  Repealing the Act didn’t remove a barrier that made the financial crisis possible.

Regular readers shouldn’t be surprised by this because they know the necessary condition for a financial crisis to occur is opacity and the trigger for a financial crisis is the valuation story Wall Street tells about opaque securities is called into doubt.  Neither of these are addressed by Glass-Steagall.

Glass-Steagall prevented Wall Street investment banks from taking insured deposits.  At  the same time, it prevented banks that took insured deposits from investing in non-investment grade securities for themselves and selling customers non-governmental securities.

Had Glass-Steagall still been in place it wouldn’t have blocked banks from investing in opaque subprime mortgage-backed securities.  Despite not having access to the information needed to assess the risk of these securities, the rating firms gave these securities investment grade ratings.

Had Glass-Steagall still been in place it wouldn’t have blocked the sale of these opaque subprime mortgage-backed securities.  Wall Street firms like Goldman were selling them as quickly as they could put them together.

JP Morgan is Exhibit A the repeal of Glass-Steagall wouldn’t have prevented the crisis.  JP Morgan wasn’t a major underwriter of subprime mortgage-backed securities.  But that didn’t mean JP Morgan didn’t have a lot of exposure to these securities.  Not only did it invest in some, but it also had a significant exposure through its lending operation.  It lent money to the non-bank firms to support their origination of these mortgages.  It lent money to Wall Street to warehouse these mortgages they bought from these non-bank firms prior to the mortgages being sold as securities.  It lent money against these securities through repurchase agreements.

Despite Jamie Dimon’s claim about JP Morgan having a fortress balance sheet, when the acute phase of the Great Financial Crisis hit investors wondered was it still solvent.  JP Morgan’s opacity hid its investment and lending exposure to the opaque subprime mortgage-backed securities.  Without this information, investors were left to wonder about the size of the losses on these investment and lending exposures.  Were they right to be worried?  In his comments to the Financial Crisis Inquiry Commission, Bernanke appeared to include JP Morgan in his observation about all but one of the Too Big to Fail banks being insolvent (the one that wouldn’t have been was likely to have been State Street because it had little exposure to subprime).

I called the Glass-Steagall myth pernicious because a decade after the acute phase of the financial crisis many are saying restoring it would prevent the next financial crisis.  Nothing could be further from the truth.  In fact, the myth diverts attention from the truth about financial crises.  The truth is financial crises are all about opacity and the size of the opaque corners of the global financial system.  The more opacity, the more likely it is a financial crisis will occur.