Back to Glass-Steagall?
President Obama shocked Wall Street recently with his proposal to cut down to size too-big-to-fail banks by imposing new rules to separate commercial and investment activities. Specifically, Obama would prohibit banks that take customers deposits from owning, investing in, or sponsoring hedge funds or private equity funds and from engaging in proprietary trading. The ban has been dubbed the Volcker Rule, in recognition of the former Federal Reserve chairman, Paul A. Volcker, who has championed the proposal.
The administration says the proposal is in the spirit of Glass-Steagall, not a return to the Depression-era law that separated commercial and investment banking. Banks with FDIC-insured deposits could still perform investment banking and brokerage activities on behalf of clients — operations that commercial banks were prohibited from conducting before Glass-Steagall was repealed in 1999.
Bringing back Glass-Steagall, however, is an idea attracting some high-profile congressional advocates, including Republican Senator John McCain and Democratic Senator Maria Cantwell. Writing in the Financial Times, HBS senior lecturer Robert Pozen, author of Too Big To Save? How to Fix the US Financial System, warns that “reinstatement of Glass-Steagall would increase the likelihood that the government would bail out a large financial institution in the future.”
Meanwhile, the proposed Volker Rule has its weaknesses. Chiefly, it won’t curb the creation of exotic securities, like collateralized debt obligations or derivatives, that contributed mightily to the financial market meltdown in 2008. So the question arises, would the Volker Rule really prevent another financial crisis?
HBS professor David Moss argues that regulation (http://www.alumni.hbs.edu/bulletin/2009/june/toobig.html) is the best way to head off future financial meltdowns and deal with institutions that are too big to fail. Specifically, he advocates: higher capital requirements; leverage limits; FDIC-like insurance charges; and, when all else fails, a receivership process to restructure, sell, or liquidate a failing company. Many of these proposals already are incorporated in legislation that has stalled in the House and Senate. So far, too big to fail has turned out to be too hard for Capitol Hill to handle.
