Giles Fraser: Go back to controls for casino banks

27 January 2010

They called it the Roaring Twenties. The war was over and the good times rolled. For six years in a row, the Dow Jones index went up and up. Ordinary Americans kept piling their money into shares that magically turned gold into more gold. Then came the great crash of 1929. Thousands of banks went bust. Many lost every­thing. The Great Depression had begun.

Four years later, the Glass-Steagall Act was passed into law. The idea was simple: high-street commercial bank­ing had to be separated from invest­ment banking. The purpose of this was to protect the bank-account side from the speculative, punting-on-the-stock-exchange side. In this way, if the investment-banking bit went down, it could not suck the bank ac­counts of ordinary people down with it. No bank could be too big to fail.

But in 1999, after years of lobby­ing by banks that were keen for more freedom to use the money of depos­itors as the basis for more speculative investments, the Glass-Steagall Act was repealed. So banks started their investment (of ordinary people’s money) in complex derivatives and fiendishly difficult-to-understand collateralised debts. As it happens, these bets were made against mort­gages that people could not afford.

The rest is history. As the banks looked to be going under, govern­ments across the world had to step in to protect the savings of the banks’ customers. Thus we all came to bail out the bankers.

Last week, Barack Obama made a move to reintroduce some new ver­sion of the old Glass-Steagall Act, limiting the activities of investment banking, especially “casino-bank­ing” proprietary trading. The Conserv­ative Party has intimated that it will attempt something similar here if it gets into power.

Unsurprisingly, the banks have reacted furiously: their lobbyists have gathered at the World Economic Forum in Davos to fight against it. As the financial expert George Soros explained, it “would certainly mean the end of Goldman Sachs as we know it.” Their argument is that this new legislation will not work. These days, finance is far too interrelated for such separation to be achievable.

Many good and clever people think that the best way to protect depositors is to make it compulsory for banks to have greater capital requirements — to set more money aside as security against potential losses in proprietary trading. But I still favour the red-line clarity of Glass-Steagall.

Is it a coincidence that the finan­cial irresponsibility of the past dec­ade followed sharp on the repeal of Glass-Steagall? Can it really be so tough to implement, if it worked for most of the 20th century (and still does in China)? One thing is sure: if a bank is too big to fail, it is too big to exist.

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