Corporate Governance

Reinstating Glass Steagall: Part 1

By J. Robert Brown

We on this Blog opposed the repeal of Glass Steagall, predicting that it would result in the demise of independent investment banking firms.  The case was made in: The "Great Fall": The Consequences of Repealing the Glass-Steagall Act.  It seems that the sentiment for bringing back Glass Steagall has continued to grow.  Steny Hoyer in the House indicated support.   So has Senators McCain and Cantwell. 

Glass-Steagall is of course Depression era legislation that separated investment and commercial banks.  Those taking deposits were prohibited from engaging in securities activities; those engaging in securities activities were prohibited from taking deposits. 

There are a number of reasons why renewed consideration of the separation makes sense.  Over the next few posts, however, we will discuss one of them.  As a matter of international practice and history in the United States, the absence of a separation of commercial and investment banking with respect to primary offerings results in commercial banks eventually controlling the market.  This is because they are more conservatively managed and have inherent funding advantages (particularly deposits). 

This risk aversion and the inherent conflict of interest by commercial banks (they favor debt relationships over the sale of securities) will likely harm the securities markets.  We are already seeing a decline in IPOs, something that may be explained at least in part by an absence of any significant number of independent investment banking firms.  We will look at some of the supporting evidence over the next few posts. 

For more on this topic, see Of Brokers, Banks and the Case for Regulatory Intervention in the Russian Securities Markets. 

Full post as published by The Race to the Bottom on December 22, 2009 (boomark / email).