New Agenda Right Time to Break Up Big U.S. Banks

Support for the idea that big U.S. banks should be broken up, with commercial and investment operations separated, has been growing since the last financial crisis. Calls for such a split are now coming from right across the political spectrum.
A Bank of America branch in New York. Photo: Eric Thayer/Bloomberg

It is rare to see this much unity in the United States. Donald Trump supports the idea, and so does a large portion of the Republican Party. Bernie Sanders is for it, and he is joined by most of the Democratic Party. Tom Hoenig, the vice chairman of the Federal Deposit Insurance Corporation who is known as an especially strict bank regulator, also favors the idea, as does Neel Kashkari, president of the Federal Reserve Bank of Minneapolis. And, finally, so does John Reed, a former C.E.O. of Citigroup.

What are we talking about? Quite simply, a return to the system of institutional separation of commercial and investment banking functions in the United States.

The Banking Act of 1933 was enacted after the great economic and financial crisis to make the financial system in the United States safer. The basic principle was that banks should engage in either the traditional deposit and lending business or the securities business, but not both at the same time.

The law, also named the Glass-Steagall Act, after its Congressional sponsors, was softened in the 1990s and eventually repealed. At the height of neoliberalism, before the 2008 financial crisis, the motto was, "everything should be left up to the market" – but then the markets only just managed to survive, and only with government support.

So since the last financial crisis, the debate over reintroducing the separation of commercial and investment banking has been rekindled.

Many argue that banks should not speculate with their customers’ savings, which is why the deposit business should be separate from the securities. But this is a naïve point of view.

Now that Mr. Trump and the Republicans have revived the issue, Wall Street is suddenly taking it seriously. Until now, it was assumed that the movement could not secure the backing of a political majority, despite broad and diverse support for the concept. But that assumption is no longer quite as certain.

An agreement could accommodate those on the left, who want to break up the banks, and encourage them to make a few concessions to the right. For the most part, the Republicans hate the banks, if only because this is the popular sentiment. But despite the fact that they helped draft it, they also hate the incredibly detailed Dodd-Frank Act, which imposes a myriad of rules on banks to prevent overly risky behavior. For the right, it would be an attractive deal to simplify these rules and, in return, to agree to go back to the separation of commercial and investment banking.

Of course, many are against the idea. So far, Mr. Kashkari has been the only one to support it within the Fed. And the banks themselves don't want to be broken up. Jamie Dimon, the head of JP Morgan, has been the most vocal opponent of breaking up the banks.

But would a return to Glass-Steagall even be justified? Some analysts believe that if large banks are broken up, the sum of their parts would have a higher market valuation than when they were combined as a single corporate entity. It's safe to assume that not everyone agrees. Mr. Dimon is right when he points to synergies in service and marketing, which speak in favor of large banks encompassing both commercial and investment banking. Another factor is that having multiple divisions within a single bank helps to balance risk, in the event that some units are not always performing well.

More important is the fact that the concept of separating commercial and investment banking functions would probably make the financial system safer. The critical point is that the big banks are too big and breaking them up would make them smaller again.

The same argument applies in Europe, where there are sometimes very large banks headquartered in relatively small countries, even more so than in the United States. The business model of Deutsche Bank is also repeatedly discussed, where a large investment bank rests on the foundation of a relatively weak traditional bank.

Critics often object that Lehman Brothers, the financial institution that caused the financial crisis to boil over with its bankruptcy, was purely an investment bank, so that Glass-Steagall wouldn't have made a difference in the Lehman case. That's true. But the real question is: What would have happened if Lehman had been a universal bank, that is, if it had also operated a traditional business in accordance with investment banking rules? Then the bankruptcy would have been even larger and more difficult to control.

The standard argument for the separation of commercial and investment banking is that banks should not speculate with their customers' savings, which is why the deposit business should remain separated from the securities business. But this is a naïve point of view. Banks of any type can be connected to one another in various ways, so that the separation of business units does not automatically translate into a separation of risks.

But in the end, the bigger and more complex banks are, the more difficult any crisis is to overcome. The system of separating commercial and investment banking helps to counteract this. It may not be a panacea – which doesn’t exist anyway. But the bottom line is that benefits probably outweigh the drawbacks.

Of course, the tedious divestiture of business units would be an organizational nightmare for banks. But if they have truly simplified their structures in recent years, as many claim, they are already halfway toward divestiture.


The author is a correspondent in New York. You can reach him at: [email protected]