Another Voice for Resurrecting Glass Steagall

Congressman Conyers has announced that he will introduce legislation to provide for a "modernized and updated version of the Glass-Steagall Act."  It is part of the growing recognition that complete repeal was a mistake, something pointed out in The "Great Fall": The Consequences of Repealing the Glass-Steagall Act, a piece published before repeal occurred.  Much of the focus so far has been on the need to restrain deposit taking banks from engaging in higher risk practices associated with investment banking activities. 

But there is another, more subtle issue that supports separation.  The international and historical evidence demonstrates that once commercial banks are allowed to engage in investment banking activities, they eventually dominate the business, with independent investment banking firms (essentially brokers rather than banks) ultimately eliminated or consigned to an insignificant niche.  

Because commercial banks are typically more conservatively managed and because they favor debt over equity, the elimination of independent investment banking firms threatens the depth and liquidity of equity markets.  Investment banking firms, in contrast, make money from the market and benefit from more active trading markets. 

Thus, in Of Brokers, Banks and the Case for Regulatory Intervention in the Russian Securities Markets, I marshalled the evidence that this was the case and argued that Russia should adopt a version of Glass Steagall in order to permit its capital markets to more completely develop.  This crisis has resulted in the elimination of independent investment banking firms, with Merrill and Bear now owned by commercial banks, Lehman gone, and Goldman and Morgan having converted to banks.  

Resurrecting Glass Steagall would presumably allow for the return of independent investment banking firms, with entities like Goldman and Morgan likely to revert back to their prior status.  This in turn would allow for the survival of a class of intermediaries uniquely committed to active securities markets.