SEPARATION OF BANKERS AND BROKERS:

If Congress hadn’t reversed a six decade old legislation, would we be in the mess we are today?

There is a legitimate reason why Thomas Jefferson insisted on the separation of Church and State – despite having deeply religious convictions, he understood that intermeddling between the two would be “dangerous” and “injurious to others.”

A hundred and fifty one years after Jefferson's guidance to us all, the US Congress passed a piece of legislation known as the Glass-Steagall Act – in the aftermath of the Great Depression.

The Glass-Steagall Act of 1933 was also resolute in its belief in separation - that is the separation of commercial and investment banking. Congress cited that “bankers and brokers were sometimes indistinguishable” and “mixing” commercial and investment banking had led to “conflict of interest and fraud.”

This economic stabilizer, which prohibited a bank holding company to own other financial institutions and arguably refereed institutions was repealed by the Clinton Administration in 1999 and replaced with the Gramm-Leach-Bliley Act.

At the time only eight senators voted against the measure, while the rest allowed deregulation of banks, allowing them to merge with investment houses and insurance companies. It was the era of the “megabank” – a bank so big it couldn’t possibly be allowed to fail.

One of the first banks to take advantage of the new law was Citigroup, which was the largest US bank by assets in 1999. It was now allowed to underwrite and trade mortgage-backed securities, collateralized debt obligations and create structured investment vehicles (SIVs).

Almost ten years later, the US Government gave Citigroup $306 Billion to prevent it from collapsing from losses of toxic debt.

Looking back we cannot downplay the significance of repealing the Glass-Seagall Act. It is not the only factor in the current crisis, but it did blur the lines between commercial and non-commercial banking activities – in short banks over-leveraged, took unregulated risks and brought a nation down on its knees.

Senator Christopher Dodd (D-Conn), Chairman of the Senate Banking Committee said in 1999 after Glass-Seagall was repealed: “I welcome this day as a day of success and triumph...”

Food for thought!