Personal Finance Blog By MoneyRates - October 2009

It's understandable that last year's banking crisis should spark a renewed drive for financial regulation. It's unfortunate that the legislative responses so far seem to be barking up the wrong tree.

As promised (or threatened, depending on how you look at it) Senator Christopher Dodd introduced legislation designed to limit banks' ability to charge overdraft fees. It seems a piece of well-meaning legislation -- no one wants to pay a $30 fee for overdrafting an account by a few dollars. However, trying to micromanage a business via legislation can have unintended consequences.

Right now, customers have a clear choice if they don't like overdraft fees -- they can avoid overdrafting their accounts. This is not a Herculean feat -- it just requires responsible recordkeeping and spending. Just about everyone overdrafts their account at some point, but most recognize this for what it usually is -- their own mistake. They can learn from the experience and avoid repeating it.

However, if you reduce the penalty for overdrafts, will some customers be encouraged to act irresponsibly? Overdrafts cost banks money. If they can't recoup that cost via overdraft fees, they will make it up somewhere else. They may have to offer lower bank rates, such as savings account interest rates and CD rates.

Alternatively, they could be pushed further away from making their fundamental banking businesses profitable, and resort to relying more on speculative investments. We've seen that movie before -- trading profits look great when everything is going well, but they are fundamentally unstable. As last year demonstrated, they significantly leverage up the risk level of the banking system.

Consumers have choices that can reduce or even eliminate overdraft fees. Better to make them responsible for exercising those choices than to incur the unintended consequences of micromanaging via legislation.

Looking for the best rates on CDs, money market accounts, and savings accounts used to be pretty fun. Now, for many savers, it's downright frustrating.

Bank rates on deposit accounts, that is, are frustratingly low. And now, with the specter of inflation rising, savers are starting to get a little bit angry.

Inflation Good for Debt

Who are savers starting to get a little angry at is the question.

The answer to that is two-fold: one, the U.S. government, and two, people who live off debt or have lived off debt up to this point.

When inflation goes up, debt becomes less of problem. "Cheaper" dollars means, theoretically, that the burden of debt is lessened. The more money there is available, the quicker the debt gets paid or settled.

That's great news for debtors, including the U.S. government itself.

Retirement Savings Week: Let Saver Voices Be Heard

Savers are the losers in this scenario. If you save your money and the value of your goes down because there's more of it in circulation, that hurts.

This week is Retirement Savings Week. It's time to let your voice, as a saver, be heard. It's your money that's at stake. Fight for its right to be worth more in the future than it is now.

Surges in the prices of oil and gold recently are symptomatic of a looming problem: the weakness of the U.S. dollar.

Oil and gold are both traded in dollar terms, so when their prices are rising, it may not be entirely a sign of demand for those commodities. Instead, it can be a function of a weakening dollar, and given the dollar's recent slide relative to the euro, it appears that dollar weakness is an important factor in driving the prices of those commodities upward.

Concern about the dollar represents perhaps one of the biggest unpaid bills of the financial crisis. The measures taken to shore up the financial system, such as lowering interest rates and running up the deficit, are not healthy for the U.S. currency.

Why does this matter? In an economy as import-dependent as ours, a weak currency is inflationary.

On the surface, the good news would seem to be that inflation would be likely push up bank rates, from savings account interest rates to short- and long-term CD rates. However, this rise would be something of an illusion -- when bank rates rise simply to keep pace with inflation, there is no real benefit to depositors.

An even worse scenario would be if bank rates were slow to respond to a resurgence of inflation. This would result in depositors actually losing ground to rising prices.

A key factor to watch, then, in the coming weeks is the U.S. dollar. The more it continues to drift downward, the more important it will be to shop for bank rates that will keep pace with the likely rise of inflation.

Money-Rates banking expert Richard Barrington called yesterday for politicians to take another look at the Glass-Steagall Act, a longstanding financial regulation that separated banking from investment activities, and was repealed in 1999 with the Gramm-Leach-Biley Act.

While this advice to politicians certainly makes extensive sense and might lower the risk of individuals holding money in money market accounts, savings accounts, and CDs, reinstating Glass-Steagall would also present giant problems to the big banks as they're currently constituted.

Making it illegal to mix banking activities with investment activities would present, first and foremost, the giant problem for big banks of:

Not even coming close to turning a profit.

As this story from the New York Times describes, JPMorgan, Citigroup, and Goldman Sachs all had pretty darn good third quarter earnings--but those earnings were largely due to profits from trading activities.

JPMorgan Chase, for example, generated $26.6 billion dollars in the third quarter from trading bonds, stocks, and derivatives. That was good enough for an 81 percent rise in revenues for that division versus last year.

Meanwhile, the consumer banking side of JPMorgan's operations, including deposit accounts and credit card lending, remains extremely troubled. The bank has set aside $31.5 billion to cover future losses.

It would be interesting to hear from Money-Rates readers--some of the most consistent savers around--whether or not traditional banking activities should or even can be separated from trading and investment activities at this stage in the game, given current bank business models.

Care to weigh in?

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.