Monday, November 2, 2009

Glass-Steagall Gathers Steam: Separate Savings Banks From Investment Banks

The Telegraph in the U.K today has an excellent article as a follow-up to Mervin King's call for the separation of commercial banks (your everyday savings bank) from investment banks (e.g., Goldman Sachs), see our October 21st post here).

The article says that the "Glass-Steagall" firewall (between commercial banks and investment banks was incrementally removed in the UK and US starting in the 80s. Financial markets have jumped from crisis to crisis ever since. Now some heavy weights have joined Mr. King: George Soros, Sheila Bair (FDIC), John Dugan (comptroller of the currency), John Reed (former Citigroup chairman).

"Once the Depression-era legislation was repealed, and the divide gone, investment bankers were able to use taxpayer-backed deposits to take ultra-risky bets, safe in the knowledge they'd be rescued if their bets back-fired. No single act has done more to de-stabilise our financial system and turn "sub-prime" from a banking crisis into a fiscal crisis too".

"We urgently need to re-impose the firewall – separating commercial "utility" banks safeguarded by government from lightly-regulated investment banks that would then be exposed to the full force of the market. At a stroke, our banking system would be far safer and the "too big to fail" issue solved. Needless to say, this is anathema to the "universal banks" of the City and Wall Street who rely on government cash for survival and from whom politicians, in turn, receive campaign donations and cushy banking jobs once their political careers have expired".

"Conventional banks failed even before Glass-Steagall was repealed", the Government's pet commentators opine. Of course they did, but the bail-outs were infrequent and tiny compared to those today, as the losses weren't magnified by leverage.

The universal banks now argue it's impossible to draw a line between investment and commercial banking. As King says: "It's hard to see why". The reality is that existing regulations already distinguish between different bank functions when determining capital requirements.
"People say I'm old-fashioned," said Former Federal Reserve boss Paul Volcker last week. "They say banks can no longer be separated from non-bank activity – but that argument got us to where we are today".

"Our financial system has been saved from disaster, for now. But in no sense has it been fixed. Until there's a Glass-Steagall type firewall, another banking crisis looms. George Osborne maintains we can get away with tweaking the existing system. Behind the scenes, though, the shadow chancellor is "considering" re-imposing Glass-Steagall. The Tories worry, though, that if the UK did this unilaterally, the City would become "uncompetitive".

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