Obama Plan to Split Banks Could Crash Economy

 President Obama’s proposal today to bring back 1930s-like separation of
commercial and investment banks, dubbed Glass-Steagall II or
Glass-Steagall 2.0, would do little to prevent the problem of financial
institutions’ being too big to fail.

What it would do is hurt economic recovery, reduce types of financing
available to businesses big and small, and give European and Asian
financial services firms a huge competitive advantage over their U.S.

The president’s proposed regulation would leave U.S. banks, in the
phrasing of American Enterprise Institute scholar and former Treasury
Department official Peter Wallison, “too big to fail or succeed.”

The proposal puts forth nothing to stop bailouts or modernize
bankruptcy laws to make failure less systemic. Instead, it reintroduces
a Depression-era structure for banking used nowhere else in the world.
And it does nothing to stop the size or systemic dangers of the
government-created financial giants Fannie Mae and Freddie Mac that
were at the center of the mortgage crisis.

Repeal of Glass-Steagall, which took place in 1999 with the
Gramm-Leach-Bliley law that Congress passed overwhelmingly and
President Bill Clinton signed, had little to do with the mortgage
meltdown at the center of our economic woes.

Neither Bear Stearns nor Lehman Brothers was affiliated with commercial
banks. Goldman Sachs and Morgan Stanley became bank holding companies
only after they got into trouble.

As for the commercial banks that imploded, such as IndyMac, Wachovia,
and Washington Mutual, all went bust “by investing in bad mortgages or
mortgage-backed securities, not because of the securities activities of
an affiliated securities firm,” Wallison, who is also a member of the
Financial Crisis Inquiry Commission, has noted.

In fact, the crisis may have been much worse had Glass-Steagall still
been in place. As former President Clinton pointed out, the
Glass-Steagall repeal “has helped stabilize the current situation” by
allowing mergers of commercial and investment banks, such as that of
Bank of America and Merrill Lynch, to go “much smoother than it would
have been” when the law mandated a strict separation.

What’s needed is updating of the bankruptcy laws for commercial banks,
investment banks and combined operations, so that taxpayers are not
holding the bag for any of them. Even before the bailouts, longstanding
deposit insurance hazards engendered moral hazard by allowing
depositors to chase the highest interest rate without inquiring at all
to the safety and soundness of the bank.

Government entities and policies that encourage reckless lending, such
as Fannie, Freddie, and the Community Reinvestment Act, also need to be
abolished or phased out.

Meanwhile, healthy competition and innovation should be encouraged
among all types of financial institutions to get credit to the
entrepreneurs who will jump-start our economy.

Congress should raise limits on credit unions’ ability to engage in
business lending. Community banks should be allowed to raise capital
without going through the onerous accounting mandates of
Sarbanes-Oxley, especially because they already go through stringent
audits from bank examiners. And the Federal Deposit Insurance Corp.
should lift the moratorium preventing retailers such as Wal-Mart, Home
Depot, and units of Berkshire Hathaway from forming their own limited
banking operations.

In short, the biggest systemic risk is that of hazardous government subsidies to and regulation on the financial sector.