Are Strange-Bedfellows Alliances the Way to Cut the Big Banks Down to Size?

glass-steagall-actBipartisanship is rare these days, and rarer still are cases in which Democrats and Republicans come together to urge new restrictions on business. Yet here we have Democratic Senator Maria Cantwell of Washington joining Arizona Republican John McCain to propose a reinstatement of the Glass-Steagall Act. The long shot idea would turn back the clock on a key facet of ruinous financial deregulation.

In case you have forgotten, Glass-Steagall was one of the signature reforms of the New Deal era, signed into law by FDR as part of the Banking Act of 1933 (photo).  Reacting to Wall Street’s excesses of the 1920s and the stock market crash, the law mandated a separation between the speculative world of investment banking and the supposedly more prudent business of commercial banking. This forced big institutions such as J.P. Morgan to spin off their securities operations, leading to the formation of firms such as Morgan Stanley.

While many credited Glass-Steagall with promoting financial stability, by the 1980s commercial banks began clamoring to get back into the more exciting (and potentially more profitable) game of underwriting corporate securities and providing other investment services. Little by little, the Federal Reserve gave in, which only emboldened the big players. In 1998 wheeler-dealer Sandy Weill directly defied Glass-Steagall by arranging a merger of Travelers Group and Citicorp, thus creating the behemoth we know today as Citigroup. What was left of Glass-Steagall was repealed by the 1999 Gramm-Leach-Bliley Act.

The near-meltdown of the financial system has engendered new interest in the principles that had been embodied in Glass-Steagall. McCain and Cantwell are not the only ones talking about reviving the 1930s legislation. Several progressive members of the House made a similar proposal earlier this month. The idea has also been endorsed by former Federal Reserve Chairman Paul Volcker and prominent economist Joseph Stiglitz.

Glass-Steagall redux would not, by itself, solve the problems of the U.S. financial system, and it is not a substitute for wide-ranging reform. But it would put a significant crimp in the casino culture that has taken root throughout the banking world. Another advantage is that it would by necessity bring about a reduction in the size of many mega-institutions that are now considered “too big to fail” and thus must be bailed out when they screw up in a spectacular way.

The McCain-Cantwell bill, for example, would require the likes of Citigroup and Bank of America to decide within a year whether they wanted to focus on lending or securities. B of A, for instance, would have to give up its branches or its ownership of Merrill Lynch. At the same time, a purer investment bank such as Goldman Sachs could no longer pretend to be a bank holding company, the designation it adopted last year to qualify for TARP funds.

If the bill proceeds, it could also serve as the foundation for an aggressive left-right response to the financial mess. Ever since the Bush Administration and the Federal Reserve started on the road to bank bailouts last year, many progressives and many conservatives have expressed outrage at the practice but have generally talked past one another. This has helped the banks avoid having any serious strings put on their rescue packages. And it let them sidestep the most obvious solution to the problem of having financial institutions deemed too big to fail: cutting them down to size.

The biggest obstacle to restoring Glass-Steagall and otherwise curtailing the power of the big banks may turn out to be not the financial lobby but rather the Obama Administration, whose chief economist, Larry Summers, championed the final repeal of Glass-Steagall while heading the Clinton Administration Treasury Department a decade ago. Despite Obama’s recent swipe at “fat cat” bankers, he and his advisors seem to think that it’s preferable to let the financial leviathans remain in place while putting some modest restrictions on their operations.

The problem is that the giant banks have become increasingly addicted to activities such as trading — the main source of the supposed rebound in the sector — and show less and less interest in mundane matters such as lending to businesses and consumers. The Obama Administration thus comes across as a defender of aloof Big Finance while the country struggles to finance an economic rebound. The fact that progressives can find more common ground on this issue with someone like McCain suggests that strange-bedfellows alliances may accomplish more than toeing the pro-business centrist line.

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