Spooked by Glass-Steagall’s Ghost?

CAMBRIDGE – America’s long-controversial Glass-Steagall Act of 1933, which separated deposit-taking commercial banks from securities-trading investment banks in the United States, is back in the news. This separation long symbolized America’s unusual history of bank regulation – probably the most unusual in the developed world.

American banking regulation had long kept US banks small and local (unable to branch across state lines), unlike their European and Japanese equivalents, while limiting their operational capacity (by barring banks from mixing commercial and investment banking). These limits on American banking persisted until the 1990’s, when Congress repealed most of this regulatory structure. Now the idea of a new Glass-Steagall is back, and not only in the US.

Sandy Weill, Citigroup’s onetime CEO, said last month that allowing commercial and investment banks to merge was a mistake. This is the same Weill who had lobbied to gut Glass-Steagall in order to build today’s Citigroup, which put insurance companies, securities dealers, and traditional deposit-taking banks all under one roof. In fact, he engineered an agreement to merge Citi with a large insurer – illegal at the time under Glass-Steagall – and then pushed for the law’s repeal, so that the merger could proceed.

A similar debate has been underway in Britain. A commission headed by Sir John Vickers, the Oxford economist and former Bank of England chief economist, wants banks’ retail operations to be ring-fenced from riskier trading and investment banking businesses. Ring-fencing is not exactly Glass-Steagall-style separation – Glass-Steagall forbade commercial banks from even affiliating with investment banks – but it is in the same spirit.

The impetus for the rethinking is, of course, the recent financial crisis. Are Weill and Vickers right now, people are asking, or was Weill right two decades ago, when he backed allowing investment and commercial banks to merge?

That is actually the wrong question to ask first. The first question is whether Glass-Steagall’s repeal strongly contributed to the financial crisis in the US. If it did, Glass-Steagall’s repeal should be revisited, and quickly. If it did not contribute much to the crisis, keeping risky trading away from commercial banks’ deposit base may still be desirable, but not something that the financial crisis proved is necessary.

Those who say that the financial recent crisis tells us to re-enact Glass-Steagall overlook what failed and what did not: the largest failures in the 2008 crisis – Lehman Brothers, AIG, and the Reserve Primary Fund – were not deposit-taking commercial banks on which Glass-Steagall’s repeal had a major impact. AIG was a mega-insurer. Lehman was an investment bank. The Reserve Primary Fund – brought down by its purchases of IOU’s from Lehman – was a money-market mutual fund, not a commercial bank.

©RIPRODUZIONE RISERVATA