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A Modest Proposal for Bank Regulation: Revisit Glass-Steagall

October 14, 2009

| MoneyRates.com Senior Financial Analyst, CFA

A year after the banking crisis, politicians continue to posture for public consumption about imposing new regulations on the banks. So far though, congress has been more talk than action when it comes to fixing the banking system, and even that talk has merely nibbled around the edges of the problem.

Congress has taken the populist route, grandstanding with crowd-pleasing diatribes against executive compensation, corporate jets, and bank fees. However, if they want a model for banking legislation that really works, why not revisit the Glass-Steagall Act?

The Glass-Steagall Act was passed in the 1930s, in response to the last systematic banking crisis. It limited the ability of institutions to mix banking with investment activities, on the premise that risky investments could endanger bank deposits. That's a problem that now sounds eerily familiar, doesn't it?

In theory, taking the limits off banks was supposed to be a win-win. Banks could use depositor capital for a wider array of profitable activities. Those profits would make that capital more valuable, so banks would offer more competitive savings account interest rates and other bank rates to attract depositors.

So how has this worked out? After Glass-Steagall had stabilized the banking system for over sixty years, in about a decade since its repeal we've seen the banking system taken to the brink by risk, and bank rates plunge to extremely low levels.

Perhaps, then, congress shouldn't spend time trying to micro-manage banking. Instead, it needs to address something more fundamental -- separating low-risk deposits from high-risk banking activities. After all, the Glass-Steagall Act must have been pretty good legislation -- it was around for more than sixty years, but most Americans never noticed it until it was gone.

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