21st Century Glass-Steagall gives Wall Street the shivers

“Despite the progress we’ve made since 2008, the biggest banks continue to threaten the economy,” bill sponsor Senator Elizabeth Warren, a Democrat and a top financial watchdog, said. “The four biggest banks are now 30% larger than they were just five years ago, and they have continued to engage in dangerous, high-risk practices that could once again put our economy at risk.”

The so-called “21st Century Glass-Steagall Act” is named after the 1933 law that separated commercial from investment banking and its highly risk activities (investment banking, insurance, swaps dealing, hedge funds and private equity). That original Glass-Steagall Act passed after 1929’s big crash to ensure that savings and checkings deposits would be safe in case of another economic turmoil. Banks would take deposits and make loans and broker firms would be allowed to underwrite and sell securities, but they couldn’t do both.

In 1999, Democrats led by President Bill Clinton and Republicans led by Senator Phil Gramm repealed Glass-Steagall to the joy of Wall Street. Many experts blame this movement for the 2007-2008 financial crisis. “The hard-earned knowledge of 1933 had been lost in the arrogance of 1999,” New York based hedge fund manager James Rickards says.

During the financial crisis, three of the five large independent investment banks failed or were acquired (Bear, Lehman Brothers and Merrill Lynch) and the rest (Goldman Sachs and Morgan Stanley) converted to commercial banks. This means investment banking activity in America is currently dominated by commercial banks.

Why bring Glass-Steagall back? To protect taxpayers. And to reduce the size of the biggest financial institutions, minimizing the risk of a new bailout. Banks would be able to run significant risk, but not with federally insured deposits. They would have a five year transition period to split their business practices into distinct entities.

But will the Congress pass the bill? Although it has found support among some Wall Street veterans, most members of the banking industry (who were fearing Elisabeth Warren’s election to the Senate last year) will certainly lobby against this 2.0 Glass-Steagall. The Republican majority is also likely to put a spoke in Warren’s wheel. Too many interests involved.