The convention platforms of both political parties call for restoring the widely discredited Depression-era Glass-Steagall Act, which separated commercial from investment banking. What could they be thinking? Have they already forgotten the causes of the panic of 2008-09?
Some people mistakenly believe that investment banking is so risky that it should be separated from commercial banking. In truth, traditional investment banking entails very little risk and certainly less than traditional commercial banking.
Traditional investment banks engage primarily in underwriting debt and equity for corporations; providing advice on mergers, acquisitions and divestitures; buying and selling securities for institutions; and helping clients hedge their interest rate, commodity and foreign-exchange risks. Investment banks accept very little risk on their books in carrying out these activities.
In contrast, commercial banks extend credit to individuals and businesses and retain a good deal of credit and interest-rate risk. Why should we prohibit commercial banks from providing fee-based, relatively risk-free investment banking services to their clients and diversifying the sources of bank revenue?
Investment banks—and commercial banks—become risky when there is a large proprietary trading and a private equity “hedge fund” inside the bank comprising a significant percentage of the revenue. This is where danger lurks, and such trading should be strictly limited and regulated.