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Break up the Big Banks

Updated on May 12, 2012

Why did they repeal Glass-Steagall?


Return to Glass-Steagall?

What were they thinking in 1999 when they repealed the “Banking Act of 1933” better known as Glass-Steagall?

I think the U.S. imposes so many regulations that we are in an economic malaise. But I also know that some regulations are valuable. No one wants another Shirtwaist factory fire tragedy or a repeat of the depression; some regulations are good.

Glass –Steagall is one regulation that I support. This act, passed in 1933, separated the business of two kinds of U.S. banks: commercial banks (your local bank) and investment banks (your brokerage.)

Commercial banks existed for ordinary investors to deposit their savings and the money they used to operate their businesses. These commercial banks lent those deposits to support their depositors and the communities they served. Typical loans were mortgages, car loans and business loans.

Under Glass-Steagall, investment banks were free to be brokers and dealers and investors in the bigger, more risky projects that require more capital. They lent money for big projects and created investment products for futures trading, hedging, and other investment tools.

Glass-Steagall regulated both banks but commercial bank regulations were designed to make sure commercial banks did not lend too much of your deposits. Moreover, to guard against a repeat of the run on banks that occurred during the depression, Glass-Steagall instituted depositor insurance just in case the commercial banks made fatal mistakes with your deposits. The insurance continues today but that is about all that is left of Glass-Steagall.

Why was Glass-Steagall repealed? Investment bankers and commercial bankers wanted to join forces and combine their assets. They pressured our government for years to repeal the “Banking Act of 1933.” Of course they would want this merger. Investment banks can make a lot more money than commercial banks because they could, by law lend more of their assets to more risky clients. Plus, investment banks could create more investment products to make money. Shouldn’t the ordinary investor benefit from investment banking to same degree as the “fat cats?”

My answer to that question is no. I remember the repeal of Glass-Steagall very well. I was in the height of my work as an investment professional and I told everyone they would be sorry that they no longer had a safe place to deposit their money. I believe that commercial banks should not be taking more risk for more reward with my deposits.

I think local and regional banks are the best hedge against bank failures. You know what they used to say about your local bank; “if it’s not boring then they are doing something wrong.” If a local or regional or even a national commercial bank fails, it will not bring down the world. I have not heard one valid argument for keeping all deposits in one or just a few mega sized banks.

Combining both banking segments means the investment banks had more capital to invest. I like making money as much as the next buy, but I want both the opportunity to make money and the reasonable expectation that my deposits are safely earning a little bit of money.

Combing the banks, the bankers’ argued would make the U.S. more internationally competitive. Who didn’t want the U.S. to be internationally competitive? Regulators’ arguments that repealing Glass-Steagall would create risk for ordinary investors if the banks co-mingle their deposits with the investment bank activities were met with the argument that the banks would keep the lending and credit functions separate by creating separate subsidiaries and the regulators could over see that pledge. Why worry?

So here we are 13 years after the 1999 the repeal of Glass-Steagall. The ability of banks to separate credit and lending functions was a dismal failure. It was this very failure of banks to keep those functions separate and the regulators to oversee their activities that caused our most recent financial fiasco. For instance, our combined mega banks’ sub-prime loans increased to 30% from 5% during the last 13 years. Those statistics alone are ample evidence that we never should have repealed Glass-Steagall.

Now our lawmakers are trying to create thousands of pages of regulation in the Volker Bill and Dodd Frank bill to try to keep these huge banks from upsetting the global apple cart and cause another financial crisis. It seems to me they just want their names on a new bill.

Would Glass Steagall have prevented what happened to JPMorgan over the past 6 week? No the investment banks can still make billion dollar mistakes but they would not have risked my savings to do it. If we go back to Glass –Steagall, your deposits are safer because they are not pledged to high risk ventures. Moreover, when the commercial bank lends, it tends to help the clients and communities that they serve rather than diluting the local benefit your money by using it internationally or in for an investment of little value to you.

You and every other person in the U.S. take on less risk because when one bank makes a fatal mistake it does not automatically devastate you. Less cost of regulation is another benefit since the ordinary investor’s deposits, being at less risk, requires less regulation.

I believe, just like bankruptcy can be accomplished in an orderly fashion that we can go back to Glass-Steagall in an orderly fashion. Let’s break up the big banks. Too big to fail has got to go.

Very Truly Yours,

TheMoneyMadam

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