system
Given the following post, respond as if you're commenting on Reddit:
human
ELI5: How the repeal of some provisions of the Glass-Steagall Act in 2000 led to the economic problems of 2008-present. 

I'm somewhat familiar with some aspects of the contributing factors behind the economic downturn, such as the artificially created CDOs/housing bubble/AIG bankruptcy , but I keep hearing mention of the topic in the headline as a significant factor as well.  Can someone explain how Glass-Steagall fits in?
gpt
Well, this is a bit complicated. There are three levels to it. There's what Gramm-Leach-Bliley *actually did*, in terms of the law. Then there's what *actually happened* as a consequence of those changes to the law. And then finally there's *how some people interpret* those two things.

Most superficially, Gramm-Leach-Bliley reduced the extent to which the government regulates the financial sector. A lot of people just stop there. Regulation good, less regulation bad, GLB bad. But that's shallow thinking, and there's no place for it here, so we'll look deeper.

There were a number of provisions in GLB, but the one that most people want to talk about is the fact that it removed a statutory prohibition of *mergers* between banks, insurance companies and brokerages. A bank is just what you think it is; it's a depository institution. People deposit money into demand-deposit accounts (and other types of insured short-term investments, like CDs), and the bank lends that money, minus a reserve requirement, out into the capital market. An insurance company is also just what you think it is: It's a company that sells a promise to pay in exchange for periodic premiums. A brokerage is neither of those things; instead, it's a company that facilitates the buying and selling of securities — financial instruments — between private concerns, like individuals or businesses. Prior to the passage of GLB, going back to 1933 or so, it was prohibited by law for a bank to merge with an insurance company, or an insurance company with a brokerage, or any combination of those. GLB removed that prohibition.

Why is this a good thing? Two reasons: economies of scale, which is obvious, but also simple economic reality. See, commercial banks were *already* offering diverse financial services, such as securities and insurance brokerage, before GLB. The only prohibition in law was that those different types of financial institutions couldn't *merge.* There was nothing stopping a bank for reselling insurance underwriting, or facilitating the buying and selling of securities, and most banks did. So GLB got rid a weak prohibition that had little real effect except for lowering the overall efficiency of the financial sector by artificially keeping certain going concerns from consolidating their interests.

Why is it a bad thing? Well, that's subtle. See, there are those who assert that GLB *led to* the collapse of the housing bubble and the subsequent economic contraction. That's not really an assertion that can be supported by the facts. GLB actually had no real effect on the rapid expansion of the housing market or its subsequent inversion. What GLB *can* be alleged to have done was to create the complex interrelationships between insurance, depository banking and brokerage that have since come to be known by the cliché "too big to fail."

You see, when one single depository bank fails, nobody really notices. That's because we've got big, robust systems in place to deal with bank failures. When a bank approaches insolvency, the FDIC works very secretively behind the scenes to come up with a solvency/liquidity transition plan. If that bank fails, a team goes in, usually on a Friday afternoon at the close of business, and puts that plan into place. Come Monday morning, the failed bank no longer exists; its assets and liabilities have been taken over by *another* bank, as mediated by the FDIC, and everything's fine. This happens *all the time* in America, and hardly anybody ever notices.

But what if that bank is also an insurance underwriter? What if it's holding a portfolio of AAA securities that amounts to the insurance policies of a million people? What if it's *also* holding portfolios for a hundred different investment funds worth tens of billions of dollars? How do you transition *those* assets and liabilities over to another institution on a weekend? That's a classic "too big to fail" situation, although it's more accurate to call it "too big to fail *manageably."* There are simply too many assets and liabilities in play for an orderly and — most importantly — *swift* transition to occur.

"Too big to fail" became such a buzzword in 2007 and 2008 that people instantly started criticizing GLB. If GLB hadn't been passed, these big institutions wouldn't have been able to merge, and so they wouldn't have grown so massively enormous that the government had to step in with TARP rather than letting them collapse and moderating the transition of assets and liabilities.

Except there's just one little problem with that. It's actually false. There have only been a *handful* of mergers between depository, underwriting and investment institutions in the past decade … and the results of those mergers — like JP Morgan Chase, which formed out of the merger of the investment bank JP Morgan and the depository bank Chase Manhattan — did *better* over the past five years than less diversified institutions, like Lehman Bros. In fact, because GLB removed the merger restriction, Bank of America was able to buy Merrill Lynch in 2008. If it hadn't, Merrill would've failed just like Lehman did.

So while a lot of people like to talk about how GLB caused all everybody's problems, there's really a very compelling case to be made that the repeal of the merger prohibition actually *softened* the blow, and resulted in fewer institutional failures than we would've seen otherwise.

So long story short? It's not simple. Some people like to make it sound all black-and-white, like there was just absolute good and absolute bad and nothing in between, but the truth is the financial sector is big and complicated, and the same change that allowed "too big to fail" to exist in the first place also kept the economy as a whole from being hit even harder by the contraction than it was.