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September 2012

Issue for Congress: “Too Big to Fail” Banking

Former Citigroup CEO Sandy Weill made a startling statement at the end of July that most Americans probably missed. He argued that banks taking deposits should be separated from their investment banking arms. His statement is particularly notable because he not only put together Citigroup, one of the largest banks in the world, but he was also a leading voice for repealing the Glass-Steagall Act, a law prohibiting the co-ownership of deposit banks with investment banks.

Weill’s statement to CNBC is as follows: “What we should probably do is go and split up investment banking from banking. Have banks be deposit takers, have banks make commercial loans and real estate loans. And have banks do something that is not going to risk the taxpayer dollars, that’s not going to be too big to fail.”

The Glass-Steagall Act was also known as the Banking Act of 1933. This law followed the Wall Street crash of 1929, a crash that was blamed in large part on banks lending to stock market “speculators” and to banks underwriting likely worthless securities sold to bank depositors. The law greatly limited bank speculation by curbing many commercial bank securities activities and severing the affiliations between commercial banks and securities firms. (Wikipedia is a great source for historical information on the Glass-Steagall Act: http://en.wikipedia.org/wiki/Glass%E2%80%93Steagall_Act.)

This same law also established the Federal Deposit Insurance Corporation (FDIC) and created a bank insurance program to ensure depositors would be able to get back at least some of their money if their bank failed. This new law came as a result of the relatively sudden collapse of many Wisconsin and national banks at the same time as the Wall Street crash. This event made a lasting impact on many Americans. My father often told me about when the local Sheboygan County bank collapsed, thereby leaving his parents essentially penniless at the start of the Great Depression.

The Glass-Steagall Act’s prohibitions were steadily eroded over time because of concerns that regulation was harming the international competitiveness of American banks. In response, President Bill Clinton and key Republican leaders of Congress successfully repealed Glass-Steagall in November 1999. Beginning in 2000, bank holding companies then became “financial holding companies” and broadly expanded into securities and insurance.

Fast forwarding to today, many observers, including former Citigroup CEO Weill, argue banks likely should not have been allowed to get into investment banking, citing the catastrophic banking failure our country faced in the fall of 2008. As most everyone knows, this led to a multi-billion taxpayer-funded bailout of the nation’s largest banks, and this could happen again. An unfortunate reminder of this potential came this summer when JP Morgan CEO Jamie Dimon said his bank had lost $5.8 billion from inadequately monitored overseas speculative trading.

A sharply divided Congress is not likely to consider re-creating the barrier that once stood between deposit and investment banking, but it seems quite clear that the taxpayer is still on the hook if “too big to fail” banks get back into financial trouble. What should be done, if anything? Perhaps this is an issue you might want to discuss with your local candidate for Congress.

 


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