Former Republican Presidential candidate John McCann and Democrat Elizabeth Warren have introduced a bill to reinstate the Glass-Steagall act which split investment and commercial banks. The reason for the repeal of the act 13 years ago was that financial services group wanted to offer a one-stop shop. Companies could access both syndicated loans and equity, individuals could buy insurance, mortgages, and stocks all in one place. However all this being said it was Lehman Brothers and Bear Stearns, who were purely investment banks, that brought the financial sector to its kness not financial supermarkets. This doesn’t consider the fact that both Citigroup and Bank of America owners of investment banks Soloman Smith Barney and Merrill Lynch respectively needed to be bailed out by the government. Also moral hazard was prevalent in that banks knew they were too big to fail therefore were encouraged to take more risks and where the rewards were greater but also the downsides. Over the last 10 years US banking has grown far more concentrated. In the mid-1990’s the biggest 5 banks accounted for about 13% of assets. By 2009 this was 38%.
If you look at the 7 decades since Glass-Steagall there were hardly any bank runs but more importantly growth was constant. Before the crash of 1929 bank runs were endemic but with public bank deposits not being able to be used for investment banking the problem was overcome. Whether anything will come of this bill to reinstate Glass-Steagall is doubtful as the financial services lobby group still remains very influential in Washington.
I blogged on this issue last year and used the metaphor of an oil tanker to explain how the split between investment and commercial banks works.
To explain the root cause of the financial crisis George Soros uses an oil tanker as a metaphor. In the movie documentary “Inside Job” he basically said that markets are inherently unstable and there needs to be some sort of regulation along the way. The oil tanker has quite an vast frame and, in order to stop the movement of oil from making the tanker unstable, shipping manufacturers have designed them with approximately 8-12 compartments, depending on the size. This maintains the tanker’s stability in the water.
After the Deperession the Glass Stegal Act was passed in 1933. This act separated investment and commercial banking activities. At the time, “improper banking activity”, was deemed the main culprit of the financial crash. According to that reasoning, commercial banks took on too much risk with depositors’ money. Therefore to use Soros’ metaphor, a compartment was put into the tanker to make it more stable.
However, in 1999 Gramm–Leach–Bliley Act effectively removed the separation that previously existed between investment banking which issued securities and commercial banks which accepted deposits. The deregulation also removed conflict of interest prohibitions between investment bankers serving as officers of commercial banks. Therefore, the tanker had a compartment/s removed which made it very unstable and it eventually capsized. Consequently the deregulation of financial markets has led to the end of compartmentalisation.