What If Wall Street Implemented Different Financial Regulations?

The Actual History

The late 20th and early 21st centuries witnessed a significant shift in the American financial regulatory landscape, characterized by progressive deregulation followed by a devastating crisis and subsequent re-regulation. This period fundamentally reshaped global finance and the world economy.

The story begins with the Glass-Steagall Act of 1933, a Depression-era law that separated commercial banking from investment banking. For decades, this firewall prevented deposit-taking institutions from engaging in risky securities activities. However, by the 1980s and 1990s, financial innovation and globalization created pressure to dismantle these restrictions. The Federal Reserve began allowing commercial banks to derive limited revenue from investment banking activities, gradually eroding Glass-Steagall's effectiveness.

In 1999, the Gramm-Leach-Bliley Act (GLBA) formally repealed key provisions of Glass-Steagall, allowing financial institutions to combine commercial banking, investment banking, and insurance services under one roof. This created massive financial conglomerates like Citigroup and enabled traditional commercial banks to expand into riskier activities.

Simultaneously, derivatives markets—financial instruments whose value is derived from underlying assets—expanded dramatically. The Commodity Futures Modernization Act of 2000 explicitly exempted over-the-counter derivatives from regulation by the Commodity Futures Trading Commission. This created a vast unregulated market for financial products like credit default swaps, which would later play a critical role in the 2008 crisis.

In the early 2000s, the housing market boomed, fueled by low interest rates, lax lending standards, and the proliferation of mortgage-backed securities. Financial institutions bundled these mortgages into complex financial products, which were often rated AAA despite containing substantial subprime loans. The securitization process obscured risk and disconnected lenders from the consequences of their lending decisions.

By 2007, the housing bubble began to collapse as subprime borrowers defaulted on their loans. Financial institutions holding mortgage-backed securities and related derivatives faced massive losses. In March 2008, Bear Stearns collapsed and was acquired by JPMorgan Chase with government assistance. The crisis reached its zenith in September 2008 when Lehman Brothers filed for bankruptcy, triggering a global financial panic.

The ensuing Great Recession was the worst economic downturn since the Great Depression. The U.S. government responded with unprecedented interventions: a $700 billion Troubled Asset Relief Program (TARP), Federal Reserve emergency lending programs, and the rescue of American International Group (AIG), among others.

In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, the most comprehensive financial regulatory reform since the 1930s. It established the Consumer Financial Protection Bureau, implemented the Volcker Rule (restricting banks from certain investment activities), enhanced regulation of derivatives, and instituted new mechanisms for resolving failing financial institutions.

However, implementation of Dodd-Frank was gradual and contested. Many regulations were weakened during the rulemaking process due to industry influence. Beginning in 2017, some provisions were formally rolled back, including threshold adjustments that exempted medium-sized banks from enhanced supervision.

The 2008 crisis permanently altered the financial landscape, contributing to widened wealth inequality, populist political movements, and enduring public skepticism toward Wall Street. Despite stronger capital requirements and stress testing regimes for major banks, debates continue about whether the financial system remains vulnerable to systemic risks and whether current regulations adequately address the fundamental issues that led to the crisis.

The Point of Divergence

What if Wall Street had implemented different financial regulations? In this alternate timeline, we explore a scenario where the financial industry embraced a stronger self-regulatory approach in the mid-1990s, fundamentally altering the course of financial history.

The point of divergence occurs in 1996, when the Federal Reserve under Alan Greenspan was considering further relaxation of restrictions on commercial banks' securities activities. In our timeline, Greenspan—a firm believer in market self-regulation—continued pushing for looser restrictions, famously stating that "private counterparty supervision remains the first line of regulatory defense."

In this alternate timeline, however, several catalysts converge to create a different outcome:

First, the collapse of Barings Bank in 1995 (when trader Nick Leeson's unauthorized speculation led to $1.3 billion in losses) sends a more profound shockwave through the global financial community. In this timeline, several major Wall Street firms identify similar vulnerabilities in their own risk management systems, creating an industry-wide moment of introspection.

Second, influential Wall Street leaders—potentially including figures like John Reed of Citicorp, John Mack of Morgan Stanley, or Richard Grasso of the NYSE—form a coalition advocating for "intelligent regulation" rather than pure deregulation. This coalition proposes that maintaining certain regulatory barriers while modernizing oversight would better serve both long-term market stability and Wall Street's reputation.

Third, the 1997-1998 Asian Financial Crisis unfolds slightly differently, with American financial institutions sustaining more significant direct losses from their exposure to troubled Asian economies. This concrete demonstration of contagion risk strengthens the position of regulatory advocates within the financial community.

These factors could have collectively shifted the risk-reward calculation for major financial institutions. Rather than continuing to lobby aggressively for complete deregulation, this coalition of Wall Street leaders might have proposed a "Third Way" regulatory framework that preserved key safeguards while allowing for financial innovation within controlled parameters.

Alternatively, this divergence might have stemmed from cultural changes within leading financial institutions. Perhaps a generation of executives who remembered the financial instability of earlier eras gained more influence, bringing their historical perspective to bear on regulatory discussions. Or possibly consumer advocacy groups found more effective ways to partner with elements of the financial industry to promote responsible practices.

Whatever the specific mechanism, in this alternate timeline, Wall Street embraces a different vision of financial regulation—one that acknowledges the need for structural safeguards against systemic risk while still enabling innovation and profitability.

Immediate Aftermath

Modified Glass-Steagall Preservation

In our timeline, the complete repeal of Glass-Steagall in 1999 allowed for the creation of massive financial conglomerates combining commercial banking, investment banking, and insurance. In this alternate timeline, the financial industry's reform coalition advocates for a modernized version of Glass-Steagall rather than its elimination.

The resulting Financial Services Modernization Act of 1999 maintains core firewalls between commercial and investment banking while allowing for limited collaboration in specific, heavily-regulated domains. Commercial banks can offer certain securities services to their clients, but cannot engage in proprietary trading or maintain large trading books of securities. Investment banks remain separate entities with higher risk profiles but without access to the federal safety net available to commercial banks.

John Reed, in this timeline still CEO of Citicorp, states: "We can serve our clients effectively without dismantling the safeguards that have protected our financial system for decades. Innovation doesn't require abandoning prudence." Citicorp and Travelers still merge, but with a modified structure that maintains greater separation between banking and insurance operations.

Derivatives Market Regulation

Rather than leaving over-the-counter derivatives entirely unregulated, Wall Street firms in this timeline propose and support a framework for standardization and oversight of these increasingly important financial instruments. The Coalition for Responsible Innovation in Finance, a hypothetical industry group in this alternate timeline, works with the Commodity Futures Trading Commission to develop the Derivatives Trading and Transparency Act of 2000.

This legislation establishes:

Mandatory clearing requirements for standard derivatives through central counterparties
Position limits for speculative trading in certain derivatives markets
Capital requirements for major derivatives dealers
Reporting requirements creating transparency in previously opaque markets

Brooksley Born, who in our timeline warned about the dangers of unregulated derivatives markets but was sidelined, finds industry allies in this alternate reality. Goldman Sachs CEO Henry Paulson becomes an unexpected advocate, stating: "Standardization and transparency benefit everyone in the long run. Properly regulated derivatives markets will be more sustainable and ultimately more profitable."

Mortgage Lending Standards

The early 2000s still see a housing boom in this alternate timeline, but with crucial differences in mortgage lending practices. The combination of maintained regulatory barriers and industry self-policing leads to:

Industry-wide standards for income verification on mortgage applications
Limits on loan-to-value ratios for higher-risk borrowers
Restrictions on the most exotic mortgage products
Enhanced disclosure requirements for mortgage-backed securities

The Mortgage Bankers Association establishes a "Sustainable Lending Certification" program that becomes the industry standard. While subprime lending still expands, the most predatory practices are curtailed. Securitization continues but with greater transparency about the underlying loan quality.

Federal Reserve Policy

Alan Greenspan, influenced by the more cautious approach of the financial industry in this timeline, adopts a slightly different monetary policy stance. While still keeping interest rates low following the 2001 recession, the Fed introduces macroprudential tools earlier:

Higher capital requirements for rapidly growing lending segments
Countercyclical capital buffers that increase during boom times
Stress testing methodologies for major financial institutions
Targeted measures to cool overheating housing markets

In his Congressional testimony in 2004, this alternate Greenspan notes: "While innovation in financial markets has created substantial benefits, we must remain vigilant about the accumulation of risk in the system. The Federal Reserve is working with industry partners to ensure that prosperity doesn't sow the seeds of future instability."

International Impact

The different regulatory approach in the United States influences international financial regulation. The Basel Committee on Banking Supervision, responding to American leadership, develops a more robust Basel II framework that places greater emphasis on systemic risk and interconnectedness between financial institutions.

European regulators, initially skeptical of what they see as American over-caution, gradually adopt similar approaches as they witness the stability benefits. The United Kingdom's Financial Services Authority implements parallel measures, creating greater regulatory consistency across major financial centers.

By 2006-2007, the global financial architecture in this alternate timeline features stronger safeguards while still allowing for innovation and profit. The structural changes don't prevent all excesses in the housing market, but they significantly contain the potential for systemic contagion when the inevitable correction begins.

Long-term Impact

The Modified Financial Crisis of 2007-2008

In this alternate timeline, the housing market still experiences a correction beginning in 2006, but the consequences unfold very differently. The maintained separation between commercial and investment banking means that housing market troubles don't immediately threaten the entire banking system.

When mortgage defaults rise in 2007, financial institutions face losses, but these are largely concentrated in specialized entities rather than systemically important banks. The regulated derivatives market provides greater transparency about which institutions are exposed and to what degree. Risk is less concentrated and more visible.

Specific Differences:

Bear Stearns: Still faces significant trouble but undergoes an orderly recapitalization and partial sale rather than a last-minute rescue.
Lehman Brothers: Experiences severe losses but the transparent derivatives registry gives regulators early warning. Rather than a chaotic bankruptcy, Lehman undergoes a structured resolution with core operations acquired by a consortium of financial institutions.
AIG: Its Financial Products division has been unable to build such an enormous portfolio of credit default swaps due to the position limits and capital requirements in place. Its troubles are significant but manageable.
Commercial Banks: Protected by the modified Glass-Steagall provisions, major commercial banks like Bank of America and Citibank face losses on their mortgage portfolios but remain fundamentally stable.

The result is still a recession, but one more similar to the 2001 downturn than the catastrophic Great Recession of our timeline. Unemployment peaks around 7% rather than 10%, and economic recovery begins by mid-2009.

Governmental Response and Regulatory Evolution

Without the acute crisis of our timeline, the governmental response is more measured:

Targeted Interventions: Rather than TARP's $700 billion blanket approach, the government implements smaller, focused programs to address specific market dysfunctions.
Housing Relief: More resources are directed toward homeowner assistance programs, as the banking system doesn't require massive bailouts.
Regulatory Refinement: Instead of the comprehensive Dodd-Frank Act, regulation evolves through a series of targeted improvements to the existing framework.

The Federal Reserve still introduces unconventional monetary policy but on a smaller scale. Quantitative easing programs are more limited, and interest rates begin normalizing by 2011 rather than remaining at zero for years.

Economic Structure and Inequality

The different handling of the financial system produces significant long-term economic differences:

Banking Industry Structure

The maintained separation between commercial and investment banking creates a more diverse financial ecosystem. Regional and community banks retain greater market share, as they're not competing with massive universal banks. Wall Street firms remain highly profitable but without the implicit government backstop that benefited them in our timeline.

The financial sector as a percentage of GDP peaks earlier and at a lower level. By 2025, finance represents approximately 6-7% of the U.S. economy rather than 8-9%, with more capital flowing to productive sectors.

Wealth and Income Inequality

Without the extreme asset price effects of multiple rounds of quantitative easing, wealth inequality, while still significant, doesn't reach the extreme levels of our timeline. The housing market recovery benefits a broader segment of Americans rather than institutional investors who purchased distressed properties in bulk.

By 2025, the wealth share of the top 1% is approximately 30% rather than 38%, still high by historical standards but not as extreme. The middle class retains more of its wealth in home equity, creating greater financial stability.

Technological Innovation in Finance

The regulated environment doesn't prevent innovation but channels it differently:

Fintech Development: Financial technology still flourishes but with greater emphasis on consumer protection and systemic stability. Companies like Square, Stripe, and PayPal emerge with similar functionality but stronger compliance frameworks.
Cryptocurrency: Bitcoin and other cryptocurrencies still develop, but regulatory clarity comes earlier. By 2020, regulated cryptocurrency exchanges are integrated into the financial system rather than operating in a legal gray area.
Algorithmic Trading: High-frequency trading develops but with guardrails that prevent the most destabilizing practices. Flash crashes are less common and less severe.

Global Financial Position

The United States emerges from the modified crisis with its financial leadership position enhanced rather than diminished. The perceived success of the American regulatory approach influences global standards.

China's rise as a financial power continues but at a more measured pace. The dollar's role as the global reserve currency remains unchallenged, as the stability of the U.S. financial system reinforces international confidence.

The Eurozone still experiences its sovereign debt crisis but with less severe contagion effects from the global financial system. European banks, less exposed to toxic American mortgage assets, provide greater lending support to their economies during recovery.

Political Landscape

The altered economic trajectory significantly impacts political developments:

Populist Movements: Without the extreme pain of the Great Recession and the perception of Wall Street bailouts, populist movements on both the right and left develop differently. The Tea Party movement is smaller and more traditionally conservative, while Occupy Wall Street either doesn't materialize or remains a minor phenomenon.
Political Polarization: Economic hardship being less severe, political polarization increases more slowly. Congressional cooperation remains difficult but functional through the 2010s.
International Relations: The U.S. maintains greater economic soft power, affecting its relationships with allies and competitors alike. International institutions like the IMF and World Bank retain stronger American influence.

By 2025, the global economy in this alternate timeline is approximately 12-15% larger than in our reality, with the benefits more broadly distributed. Financial crises have still occurred—they always do—but their severity and frequency have been reduced by the balanced regulatory approach implemented in the late 1990s.

Expert Opinions

Dr. Nouriel Roubini, Professor of Economics at New York University's Stern School of Business, offers this perspective: "The alternate regulatory path described here represents what I would call 'smart regulation' rather than simply more regulation. By maintaining structural separations between different types of financial activities while allowing for innovation within defined parameters, this approach could have significantly reduced systemic risk without sacrificing economic dynamism. The critical insight is that financial stability and economic growth are complements, not substitutes, in the long run. When we allow the financial system to become excessively leveraged and opaque, we're not promoting growth—we're borrowing growth from the future at an extortionate interest rate."

Janet Yellen, former Chair of the Federal Reserve, provides this analysis: "Counterfactual scenarios are always challenging to evaluate with precision, but it's reasonable to conclude that preserving key elements of financial firewalls while modernizing their application could have resulted in a more resilient system. What's particularly interesting about this alternate timeline is how it suggests that industry self-interest, properly understood, could have aligned with broader economic stability. The massive destruction of shareholder value that occurred during the 2008 crisis—not to mention the reputational damage to financial institutions—might have been substantially mitigated through the kind of foresight described in this scenario. In retrospect, even purely from the perspective of the financial industry's long-term profitability, a more balanced regulatory approach could have been optimal."

Mark Blyth, Professor of International Political Economy at Brown University, presents a more skeptical view: "While this alternate history presents an appealing scenario, we should question whether the structural forces driving deregulation could have been so easily redirected. Financial regulation doesn't exist in a vacuum—it reflects power relationships in society. The concentration of wealth and influence in the financial sector created tremendous pressure for deregulation, and it's not clear that even enlightened self-interest would have overcome these forces. That said, what's valuable about this counterfactual is how it highlights that different choices were possible. The financial crisis wasn't a natural disaster—it was the product of specific decisions made by specific actors. Understanding that contingency is essential for making better choices in the future."