Break Up the Banks

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An Updated Glass-Steagall Is Needed

One way to restore some sanity to the system would be for the Obama Administration to call for the passage of an updated version of Glass-Steagall, the Depression-era law that barred commercial banks from owning investment banks and other financial firms. The 1999 repeal of Glass-Steagall was a colossal mistake, permitting too much risk to be concentrated in a handful of mammoth banks. The law, which served the nation's banking system well for nearly 70 years, was a natural check and balance on the growth of financial firms.

Charles Geisst, a finance professor at Manhattan College and a noted Wall Street historian, says the repeal of Glass-Steagall was a green light to Wall Street to go hog wild. It opened the door to an explosion in risk-taking with derivatives and securitization. That model was emulated around the globe.

Geisst says it's too late to undo the globalization of the world financial system—the interconnectedness of derivatives makes that almost impossible. But it's not too late to revive an updated version of Glass-Steagall and break apart the giant banking behemoths that have emerged over the past decade since the law was obliterated. "The original Glass-Steagall wasn't just a banking law; it also was a very good form of antitrust law," says Geisst.

Prohibiting Outsize Market Dominance

A 21st century Glass-Steagall should bar certain banking combinations and impose caps on certain investment banking activities by commercial lenders. The goal should be to prevent a handful of banks from dominating the market for exotic investment products. It's plain crazy that 96% of the total notional value of all derivatives contracts is concentrated in the hands of five U.S. banks, which now includes Goldman following its conversion to a bank holding company. There probably also need to be some limits on the number of countries any single bank or financial firm can operate in.

"JPMorgan will need to get split up again," says Geisst. "You are going to separate commercial banking and investment banking again. And what we created with Citi was something that was too big to fail. We allowed an institution to be created that was too big for its own good and too big for its management."

The bankers will no doubt argue that all of this will stifle financial innovation and make it harder for companies to raise capital once the economy stabilizes. That may be so. But it's worth accepting a little less growth if it means avoiding more big bank bailouts down the road.

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Goldstein is a senior writer at BusinessWeek.

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