Senators Introduce Bill to Separate Trading Activities From Big Banks

By:  The New York Times - Peter Eavis
Source: The New York Times

Senator Elizabeth Warren on Thursday introduced an aggressive piece of legislation that intends to take the financial industry back to an era when there was a strict divide between traditional banking and speculative activities.

The bill, which is also sponsored by Senator John McCain, Republican of Arizona, and two other senators, is named the 21st Century Glass-Steagall Act. Its intention is to create a modern version of the seminal Glass-Steagall legislation from the 1930s, which placed firm limits on what regulated banks could do. It was fully repealed in 1999, laying the groundwork for the mergers that created some of the biggest banks of today. If passed, it could force many of those banks to let go of their trading operations.

Senator Warren’s bill is one of several that have aimed to add far more bite to the overhauls that have been put in place since the financial crisis. The bill serves as a jarring reminder to Wall Street of why it feared her election to the Senate last year.

“Over the past five years, we’ve made real progress,” said Senator Warren, Democrat of Massachusetts. But, she added, “The biggest banks continue to engage in dangerous high-risk practices that could once again put our economy at risk.”

Similarly stringent banking bills introduced in the last few years have struggled to gain sufficient votes in Congress, and this one may be no different. In addition, a move as radical as splitting up large banks is highly unlikely to gain the support of top regulators like the Federal Reserve or the Treasury Department.

“It seems mainly symbolic,” Phillip L. Swagel, a professor at the University of Maryland School of Public Policy, said. “This is a handle that people can grab to move the debate toward more regulation.”

Senator Warren seemed to acknowledge the battle ahead, but she said that having Senator McCain as an ally was an advantage. “He’s a fighter, and it’s going to take a fighter to get this Glass-Steagall bill through,” she said in a news conference.

Nostalgia for the original Glass-Steagall Act might help the new bill gain interest. Its supporters say the former law had several straightforward benefits, in contrast to the complex regulations that have been put in place since the crisis, like the Dodd-Frank Act of 2010. Glass-Steagall, which had 37 pages, was simple and so easy to put into practice, they say.

The act also kept banks that use federal deposit insurance out of potentially volatile Wall Street activities, including certain types of trading. As a result, problems at investment banks were less likely to infect regulated banks. Losses at the Wall Street operations of Citigroup and Bank of America weighed heavily on those banks during the 2008 crisis.

“For about 70 years, Glass-Steagall managed to keep the riskier, more damaging part of Wall Street away from what should be the boring, straightforward side of finance,” Barry L. Ritholtz, chief executive of FusionIQ, an asset management and research firm, said. “It was the height of stupidity repealing Glass-Steagall.”

During the era of Glass-Steagall, there were no systemic banking crises like the one that occurred in 2008. The restrictions the bill put on the financial sector did not seem to do much wider harm. According to analysis of government gross domestic product statistics, the American economy grew an average of 4 percent a year from 1933 until 1999, when Glass-Steagall was in effect. Even some who championed repealing the act, like the former Citigroup chairman Sanford I. Weill, have since called for the breakup of the bank behemoths.

Still, critics have a full arsenal of arguments to deploy against reintroducing it.

One is that Glass-Steagall would not have stopped the 2008 crisis. The act, for instance, would not have prohibited the growth of Lehman Brothers, which collapsed and spread panic through the financial system.

Another argument is that the American economy actually benefits from large banks that can make ordinary loans as well as trade securities and derivatives, the financial instruments that are used for hedging risks and speculation.

“On the whole, there are benefits to having diversified financial institutions,” said Mr. Swagel, who was an assistant secretary for economic policy under Treasury Secretary Henry M. Paulson Jr.

Others say there are much better tools to make the banks safer than a new Glass-Steagall, like requiring them to hold more capital.

“It is a very crude tool to be used to downsize the large banking organizations,” Charles M. Horn, a partner at the law firm Morrison & Foerster, said.

The new bill aims to update the old Glass-Steagall for innovations that have taken place since it was enacted. The new bill would force deposit-taking banks to cease most of their trading of derivatives. Today, banks keep most of their derivatives in entities that have deposit insurance, allowing them to benefit from an effective subsidy.

The bill would give banks five years to comply with its requirements.

The other two senators sponsoring the bill are Maria Cantwell, Democrat of Washington, and Angus King, independent of Maine.

On Thursday, Senator Warren said she was not convinced that banks needed to be on Wall Street as well as in traditional business to properly serve the economy.

“I’d like to see the data on that, because I haven’t,” she said.

The bill should not be seen as a cure-all, the senator cautioned.

“The bill by itself will not end ‘too-big-to-fail’ and implicit government subsidies, but it will make financial institutions safer and smaller and move us in the right direction,” she said.