"A bipartisan group of senators recently put forward a proposal for new Glass-Steagall legislation that would restore a strict separation between commercial banks and speculative trading. Anyone familiar with the ways of Washington knows that such legislation is badly needed. It is the only way to prevent the Wall Street gang from continuing to rip off the public and subjecting the rest of us to the risks of their speculation. The idea of the original Glass Steagall was to create two completely distinct types of banks. On the one hand there would be the standard commercial banks with which most of us are familiar. These are the banks where people have checking and savings accounts and where they might go to take out a mortgage or small business loan. Because of the central role that commercial banks play in the day-to-day workings of the economy, the government established the Federal Deposit Insurance Corporation (FDIC) to guarantee the vast majority of accounts in full. The goal was to let people know that their money is safe in the bank. Since the government guaranteed the money, people need never worry about racing to the bank to get their money before the bank vault is empty. As a result we have not seen the sort of old-fashioned bank-runs that were a mainstay of the pre-FDIC era. The quid pro quo for having the government guarantee deposits was that commercial banks were supposed to restrict their loans to a limited number of relatively safe activities, such as mortgage loans, small business loans, car loans and other simple and standardized forms of credit. These restrictions are essential, because if customers know their money is guaranteed by the government, they won’t care if their bank is taking enormous risks. The government must act to impose discipline on bank behavior that will not come from the market when deposits are insured. By contrast, investment banks were set free to engage in whatever risky behavior they liked. Investment banks did not take deposits but rather raised money through issuing bonds or other forms of borrowing. In principle, their potential failure did not pose the same risk to the economy."
Posted on: Sat, 10 Aug 2013 20:07:07 +0000
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