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and thousands of small local and regional banks scattered
across the country.
    And then there were the S&Ls, small, usually local firms in the sole business of taking savings deposits and selling fixed-rate long-term residential mortgages. As late as 1980, most
S&Ls were trusts—they had no shareholders, but rather were cooperatively owned by their local “passbook” depositors. (The same was true of credit unions andmost large insurance companies.) Like banks, the S&Ls were tightly regulated, and their retail deposits were insured. They were explicitly permitted by regulators to pay slightly
higher interest rates on savings accounts than commercial banks, in order to encourage mortgage lending.
    The world on the other side of the Glass-Steagall wall—the securities industry—was divided between retail brokerages and investment banks. Brokerage firms, the largest of which was
Merrill Lynch, sold stocks and bonds to wealthy individual customers. Merrill Lynch was a large firm for this period. It was also one of the first to go public, in 1971.
    True investment banks, such as Goldman Sachs, Morgan Stanley, Bear Stearns, Dillon Read, and Lehman Brothers, provided financial advice to big companies and managed and distributed new issues of
stocks and bonds. It was a fragmented but still clubby industry, informally divided between Protestant and Jewish firms, with women and minorities welcomed by neither. There were dozens of firms,
all of them small but very stable, with low personnel turnover. In 1980 Goldman Sachs, the largest, had a total of 2,000 employees (versus 34,000 in 2011); most of the others had only a few
hundred, some only a few dozen. They were all private partnerships, and the capital they used was their own. If they underwrote (guaranteed the sale of) a new issue of stock, the partners were
literally risking their own personal money, which constituted the entire capital base of the firm. Their franchises depended on reputation and trust—though also, realistically, on golf,
squash at the Harvard Club, and old-school ties.
    Regulation, Bankers’ Pay, and Financial Stability
    BANKERS’ PAY HAD reached stratospheric levels in the 1920s but then contracted sharply with the Depression and, even more importantly, with the
tightening of regulation in its wake. After passage of the New Deal reforms, pay in the American financial sector settled down. For forty years, average financial sector pay stayed at about double
the averageworker’s income. Executive compensation, while comfortable, was hardly exorbitant; nobody had private planes or gigantic yachts. 3
    Equally important was the structure of financial sector pay. Most commercial bankers were paid straight salaries. Investment bankers lived well and received annual bonuses, but through
deliberate policy practised universally within the industry, most of the partners’ total wealth was required to remain invested in their firm, usually for decades. Partners could only take
their money out when they retired, so partners and their firms exhibited very long time horizons and a healthy aversion to catastrophic risk taking.
    All of this—the industry structure, regulation, culture, and compensation practices—remained in place until the early 1980s. Then the wheels came off.
    Drivers of Change
    IN THE EARLY 1980s, three forces converged in a perfect storm of pressure and opportunity: the upheavals of the 1970s, which destabilized and devastated
the financial markets, forcing bankers to seek new forms of income; the information technology revolution, which integrated previously separate markets and vastly increased the complexity and
velocity of financial flows; and deregulation, which placed the inmates in charge of the asylum.
    The first driver of change was severe financial pressure. In the wake of the 1973 and 1979 oil shocks, the stock market and all financial institutions suffered badly. Inflation grew so severe
that in 1981 three-month US