There Will Be No Return of Glass-Steagall

February 23, 2010 at 1:29 PM
The New York Post reports today that The Obama Administration is going to drop its plan to ban proprietary trading for commercial banks and instead require that commercial banks hold higher cash reserves if they engage in property trading. I'm sure the devil will be in the details on this, and I'd prefer to see the whole idea scrapped. Still, this watering down of the "Volcker Rule" is a welcomed relief. The dangers of mixing commercial banking and investment banking have been exaggerated. As many of you know, Senators Maria Cantwell (D-WA) and John McCain (R-AZ) have introduced a bill that would essentially reinstitute the Glass-Steagall Act. While the Obama administration claims to be against a full resurrection of the act, the President proposed the “Volcker Rule,” stating that “banks will no longer be allowed to own, invest, or sponsor hedge funds, private equity funds, or proprietary trading operations for their own profit, unrelated to serving their customers.” Both of these proposals rely on the premise that risky practices of investment bankers on Wall Street caused the current economic contraction in the same way that they caused the Great Depression; and that reinforcing the separation of investment banking and commercial banking will go a long way to prevent a future financial crisis.
This premise is simply untrue. The most recent financial crisis - much like the Great Depression - was not caused by risky proprietary trading or the losses of hedge funds operated by commercial banks, and the elimination of these vehicles would have done nothing to prevent the credit problems that sank so many financial institutions. Eliminating proprietary trading at banks would have done little to accomplish its stated goal of decreasing systemic risk and helping to prevent another financial meltdown. Instead, banks and policy makers should focus on improving risk management, internal controls, corporate governance, and supervisory oversight.
Let me know what you think.

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