March 9, 2013


Good Fences Make Good Bankers (William J. Quirk, Spring 2013, American Scholar)

Everywhere you look, the big banks continue to wallow in scandal. Bank of America, JPMorgan Chase, Wells Fargo, Citigroup, and others are being sued by prosecutors, regulators, and investors for an estimated $300 billion for fraud involving mortgage-backed securities. These are the bizarre "innovations" at the heart of the housing crisis that nearly brought down the economy in 2008, creating an international recession from which the world still suffers. On top of that, in early January of this year, 10 banks settled for $8.5 billion with federal regulators for mortgage foreclosure abuses. JPMorgan Chase, Bank of America, Wells Fargo, Citigroup, and Ally Financial agreed to pay regulators and state attorneys general $26 billion last year for the same foreclosure abuses. In November, a London jury found a bank trader guilty of the biggest banking fraud in British history; he had lost $2.3 billion in rogue trades. In December, an Italian court ruled that JPMorgan Chase was guilty of fraud in the sale of derivatives to the city of Milan.

Banks have not always caused so much trouble. The last time they did so--in the 1920s and early '30s--Congress passed the 1933 Glass-Steagall Act to prevent them from doing it again. Before writing that law, Congress convened the Pecora Investigation to inquire into the causes of the collapse. Glass-Steagall separated securities trading from traditional commercial banking--taking deposits and making loans. Heavily regulated and their deposits insured, commercial banks performed the important job of allocating capital to productive purposes. Investment banks, by contrast, could buy and sell securities. They might make a lot of money or lose a lot, but they were on their own; they kept their gains and ate their losses.

What Glass-Steagall said, as former Federal Reserve Board chairman Paul Volcker has put it, was very simple: "A bank can't trade." Glass-Steagall rested on the idea that greed, although too strong to be regulated, should be isolated--sealed off from the banking system. Because lending money and protecting savings are essential to the working of a capitalist system, Glass-Steagall required that deposit-taking banks stay out of any other business, essentially functioning as utilities. And the Glass-Steagall barriers worked. As long as the act was in effect, the country had no systemic commercial bank problems.

Posted by at March 9, 2013 10:14 AM

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