Ten years ago President Clinton signed the Gramm-Leach-Bliley Act which repealed the Glass-Steagall Act giving rise to financial conglomerates that apparently are considered too big to fail, and therefore turn to taxpayer handouts when they find themselves in financial trouble. This latest round of bailouts is already putting trillions of dollars of taxpayer funds at risk.
Congress passed Glass-Steagall in 1933 after speculative activities by large US banks brought the financial system close to collapse. Sound familiar? The intent of the act was to separate investment-banking from lending and deposit-taking. The idea is that investment banking involves more speculative and complex undertakings than commercial banking, and therefore deposit taking institutions should be limited in the amount and types of risks they assume to safekeep depositors’ funds. The repeal of Glass-Steagall allowed the creation of megabanks like Citigroup; look how wonderful that experiment turned out.
The latest round of bank failures has forced mergers that have made banks larger and more concentrated in their risks. We have moved away from a diversified banking system with varied lending practices, to a more concentrated, homogeneous structure where all banks resemble one another. We are living in an economy with fewer but larger banks which constitutes a non-diversified financial ecology ripe for another crisis. Most banks are now so interrelated that when one falls, they all fall. Our banking system is now more vulnerable than ever to even the slightest hiccup.
Congress is now considering the reinstatement of Glass-Steagall. Representative Paul Kanjorski plans to offer the legislation as early as next week. Certainly the banking industry is fighting this. Rob Nichols, president of the Financial Services Forum whose lobbyists represent the largest financial institutions contends that “the U.S. needs big financial firms.” He said he’ll be “vocal and persistent in the halls of Congress.” I believe Mr. Nichols has underestimated the anger that Americans harbor for the shenanigans that have gone on in our banks. If we don’t take the opportunity to properly fix our banking system now, large US financial institutions will undoubtedly once again be laughing all the way to the bank.