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A new Glass-Steagall Act wouldn't work

Allister Heath
WHEN the Governor of the Bank of England &ndash; and if the Tories are elected, the next chief financial regulator &ndash; calls for investment banks to be separated from retail banks, everybody should sit up and listen carefully. King seems deadly serious, and George Osborne said last night that he agreed with much of the speech. While that doesn&rsquo;t commit the Tories to introducing a UK version of the Glass-Steagall Act, the US law that separated investment banking (such as proprietary trading) from retail and commercial banking, it certainly reopens a nasty can of worms. <br /><br />On balance, however, King is wrong. There is no real evidence that any fewer UK banks would have gone bust had this separation been in place. It was not proprietary trading that brought down HBOS, it was bad lending to commercial property. Northern Rock, Bradford and Bingley and the Dunfermline did not own investment banks. RBS was brought to its knees as a result of a multitude of bad lending decisions, the over-priced takeover of ABN Amro and vast holdings of dodgy &ldquo;assets&rdquo;; its collapse was not caused by a giant investment banking bet gone wrong. In the US, it is likely that Citigroup would have required a bailout even had it not owned an investment bank. Generally, the same is true of all of virtually all the recipients of Tarp funds.<br /><br />The very distinction between &ldquo;casino&rdquo; and &ldquo;utility&rdquo; banking, while theoretically meaningful, is nonsensical in practice. The most dangerous banking activities are lending against property, a utility function; the financial system was destroyed by undercapitalised banks holding property-based assets such as CDOs which subsequently collapsed in value together with the housing market. That had nothing to do with proprietary trading, which is less systemically risky than old-fashioned lending. <br /><br />In fact, Glass-Steagall has been shown to be worse than useless by academics including Eugene White of Rutgers, Randall Kroszner and Raghuram Rajan of Chicago, and Carlos Ramirez and Alex Tabarrok of George Mason. Unified banking is safer and less prone to collapse than artificially segmented institutions. <br /><br />I strongly recommend to readers who think that King is right to read a powerful tome by George J Benston of the University of Georgia. It is a bit of a mouthful, but The Separation of Commercial and Investment Banking: The Glass-Steagall Act Revisited and Reconsidered demonstrates that commercial banks involved in security markets did not fail in large numbers or cause the 1930s crisis. Tabarrock, meanwhile, argues that Glass-Steagall was the product of an attempt by the Rockefellers to raise the costs of their rivals, the House of Morgan. <br /><br />There must be no more bailouts. Banks of all kinds that become insolvent should be allowed to go bust in a controlled, gentle manner that doesn&rsquo;t endanger the economy or take decades to unravel (depositors could still be insured, but that is a separate question). We need new resolution procedures and living wills; meanwhile, banks need to hold much greater amounts of liquid capital and central bankers mustn&rsquo;t stoke any more bubbles with excessively low interest rates. But we shouldn&rsquo;t force universal banks such as HSBC, Barclays or JP Morgan to break themselves up. Doing so may even make the system more, rather than less, prone to failure.&nbsp;&nbsp; &nbsp;&nbsp;&nbsp; <br />allister.heath@cityam.com <br />