Tuesday, 6 September 2011

Breaking up is so very hard to do

On 12 September 2011 the final report of the Independent Commission on Banking under Sir John Vickers will be issued. It is likely to recommend the ring fencing of the UK’s retail banks, and thus the separation of the riskier investment banking operations. Whether this will be accepted by the government has been cast into doubt amidst strong lobbying that it will impact on economic recovery and Britain’s future growth prospects.

Although the current economic crisis looks set to rival the Great Depression in length, it has not yet had quite the same cataclysmic social and political impacts. It is therefore unsurprising that the political response to the credit crunch and systemic failure of the banking system has not yet yielded reform on a scale comparable with those promulgated in the US in the 1930s.

The Banking Act of 1933 is more commonly known as the Glass–Steagall Act, named for the Democractic Senator from Virginia, Carter Glass, and the Democratic Congressman from Alabama, Henry B. Steagall. It was a revolutionary piece of legislation for revolutionary times.

It was enacted as part of Roosevelt’s New Deal legislation, and against the backdrop of the failure of more than 5,000 banks in the Great Depression. Most totemic of all was the failure of the Bank of United States on 11 December 1930, which saw one of America’s largest commercial banks collapse.

Confidence in America’s fiscal system was already at rock bottom when the new FDR administration attempted comprehensive surgery to revive the banks. On Monday 6 March 1933, President Roosevelt issued a proclamation ordering the suspension of all banking transactions, effective immediately. The nationwide bank holiday was to extend to Thursday 9 March, during which time emergency legislation was considered in Congress.

The emergency banking legislation was followed by the Glass-Steagall Act in June 1933. The Act forced the separation of commercial and investment banks. Commercial banks could not embark on risky trading activities (such as underwriting the sales of stocks and bonds), and investment banks could not take deposits.

Glass-Steagall was repealed in November 1999, and was followed by a wave of mergers that created the banking behemoths – the banks that were “too big to fail”.

The UK is not the only country that is considering greater regulation of its banking industry. The US has implemented the Dodd–Frank Wall Street Reform and Consumer Protection Act. The EU has agreed a new financial supervision framework, including the European Systemic Risk Board. And Basel III promises to strengthen regulation, supervision and risk management of the banking system.

But there is, as yet, no new Glass-Steagal and no new Bretton Woods, which is a shame. As economist Paul Romer noted: “a crisis is a terrible thing to waste”.

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