The Huffington Post reported on five House Democrats that are backing in opposition to the Obama Administration the bringing back the Depression era Glass-Steagall Act.  If you are unfamiliar with this act here is a basic explanation.  After the Great Depression, as part of the banking reforms put in place, we made it so our banks would have to chose between being a commercial deposit taking institution or a investment bank that underwrote securities and did trading on its own books and with its own capital.

I have heard countless experts and official explain how this is not possible or feasible as a plan.  I wonder how we got along for 59 years with this in place?  The reason it was such an important piece of legislation is because it made the core of our banking system (commercial banks with deposits) the most risk adverse form of financial company so that even if our investment banks got in over their head and a few failed, it would not directly affect the commercial banks so that was to contain the need for people to feel their bank was insolvent and then that would create a panic or “run on the bank“.

On the other hand, our investment banks were encouraged to take as much risk as they wanted to make profits with the understanding that they were on their own as far as the government as concerned so they would have to rely on the markets for their support and along with that we allow them to be unregulated so they had as much financial freedom as we could give them to innovate.

This was a very fair trade in my opinion.  One thing to remember is that both forms of banking are very profitable in there own manner.  What I hear now is because these mega-banks are so ‘used” to these enormous profits because they can operate in both areas, that somehow would make them uncompetitive compared to their peers.   I disagree, first off, the U.S. is still the number one financial center of the world hands down and is a favorite place for capital to enter so that is can be deployed.  Second, if we do nothing then we are just setting ourselves up for another situation where these major banks get into trouble and then we will have another supposed “too big to fail” situation that the only answer is “bailout” because it seems to be politically unfeasible for us to let the markets do their jobs and let the bad players fail.

Five House Democrats will call this week for a return to a Depression-era law that separated Wall Street investment banking from Main Street commercial banking.

If adopted, the measure would give banks one year to choose between being commercial banks or investment banks. The nation’s biggest — those now commonly referred to as “too big to fail” — would be broken up. The Obama administration opposes the measure.

The amendment’s five co-sponsors — Maurice Hinchey of New York, John Conyers of Michigan, Peter DeFazio of Oregon, Jay Inslee of Washington, and John Tierney of Massachusetts – want to restore the Glass-Steagall Act of 1933, which prohibited commercial banks from underwriting stocks and bonds. The act was repealed in 1999 at the urging of, among others, Larry Summers, now President Barack Obama’s chief economic adviser.

The five congressman all voted against the repeal then — and now they want it back.

Analysis: I fully support this move and hope it gains more support.  We really need to structurally shore up our banking system and get rid of this “too big to fail” doctrine and this is a step in the right direction.  Please sound off with your comments

You wouldn’t say?  John Reed hits it right on the head and he has creditability so I hope our representatives are listening to people like him and Paul Volcker who keep making the case for reenacting this beautiful piece of legislation.  It makes perfect sense to  have your most risk adverse financial institutions (commercial banks) should not be involved in the most risky activity like trading on your own books which investment banks engage in daily.

The argument I hear from the banks is that it is very profitable so that is good for the shareholders.  I respond,”then convert to a investment bank and divest your commercial banking activities”.  When we are dealing with “Too Big to Fail” banks we are inviting trouble to our doorstep by allowing this activity.  It puts depositors and the FDIC at risk if one of these banks failed but as we have shown, we will instead bailout their bad decisions and that puts the taxpayers at risk.  This form of financial welfare as got to stop and market forces need to be given a chance to bear on these situations.

Glass-Steagall Act

Lawmakers were wrong to repeal the Depression-era Glass- Steagall Act in 1999, Reed said. At the time, he supported overturn of the law, which required the separation of institutions that engaged in traditional customer banking services from those involved in capital markets.

“We learn from our mistakes,” said Reed, who wrote an Oct. 21 letter to the editor of the New York Times endorsing a division of banking activities. “When you’re running a company, you do what you think is right for the stockholders. Right now I’m looking at this as a citizen.”

Reed headed Citicorp for 14 years until the merger with Travelers. The deal created the world’s biggest financial company in a stock swap valued at about $85 billion. Reed and Weill were co-chairmen and co-chief executive officers until Reed’s retirement in 2000.

Analysis: Glass-Steagall needs to make a comeback so we can reduce the systematic risk in our financial system.  OTC derivatives reform is another area that will greatly help us address these issues we face.