A Glass Act
Sunday, September 21, 2008. 

In a story in today's Charlotte Observer, Rick Rothaker wrote of the day the news broke that the venerable Merrill Lynch would be acquired by Charlotte's Bank of America: "[a]t a restaurant at the base of the Merrill tower, the takeover news was rippling through lunchtime conversations. General manager Melonee Gilchrist said the firm's investment bankers were taking the news as expected. 'They're drinking,' she said."  I can't help but wonder if that's why they're in this mess in the first place.

As lawmakers responded to the onset of the Great Depression, the U.S. Congress passed the Glass-Steagall Act of 1933. Glass-Steagall created a firewall between commercial banks (gathering deposits and making loans) and investment banks (underwriting and selling securities).  Commercial banks were prohibited from underwriting and selling securities and investment banks were prohibited from taking deposits. So, Glass-Steagall was enacted to protect the stability of Main Street from the routine and exceptional volatility of Wall Street, which volatility is illustrated by the recent implosion of the major U.S. investment banks.

Then, in 1999, the Gramm-Leach-Bliley Act repealed the strictures of Glass-Steagall and restored the pre-Depression order. Commercial banks can be involved in investment banking and investment banks can be involved in commercial banking. The line between commercial and investment banks are blurry again. Nevertheless, the largest commercial and investment banks didn't start a merger frenzy - commercial banks were still largely lenders and investment banks were still focused on Wall Street.

But now, Goldman Sachs and Morgan Stanley have filed to convert from investment banks to bank holding companies (commercial banks); Lehman Brothers filed bankruptcy; and Merrill Lynch was acquired by Bank of America (which not long ago was a relatively small Charlotte bank called NCNB). It's hard to fathom that the largest bank in the United States will soon be headquartered in Charlotte. I guess that's why the Merrill bankers were drinking at lunch.

More important than whether Merrill bankers will have to start getting used to Carolina 'que-sine, I wonder how the economy would have handled the current crisis if the four big investment banks had been part of commercial banks all along.  Would the strength and discipline of the commercial bank have prevented the crisis?  Or will the recombination of commercial and investment banks "Leach" the stability out of our banking systems and the innovation out of our markets?

Epilogue, October 27, 2011

So much has happened since I wrote this slightly tongue-in-cheek piece.  One thing, is abundantly clear: my assumption above that "the strength and discipline of the commercial bank [might] have prevented the crisis" was premature.  It turns out that we just didn't realize at the time how how little "strength and discipline" the non-subprime commercial bank sector would be shown to have in the cold light of day.  And yet, even now there is no clear consensus over whether these mega-banks should be subject to a Glass-Steagall regulatory structure of some kind to separate commercial banking, investment banking and insurance.  The truth is, as Matt Taibi said on CNN recently, "too big to fail should be too big to exist."  The American tax payer cannot afford to allow the captains of the largest American financial and industrial powers to enjoy the privatization of profit while ordinary Americans carry the burden of the socialization of risk.  So, in addition to separating the financial functions into separate, truly unrelated entities, maybe the current cap on bank size - that prohibits bank mergers if the resulting entity would hold more than 10% of national bank deposits - should be reduced to 1% or something similarly innocuous, if such a thing could be said of any entity that held 1% of all the bank deposits in the United States of America.
 

Greed and fear, which routinely govern financial markets, have seeded this global crisis.

- Robert Samuelson, "Wall Street's Unraveling," The Washington Post, September 17, 2008

Copyright  ©  2011 Ashe Lockhart. All rights reserved.