Back to the future…

Back in the Depression of the 1930s, a number of financial market reforms were implemented to reduce the risk of those sorry events being repeated again.

One of those reforms was to separate retail banking from investment banking.  In the United States, the Glass–Steagall Act prohibited banks from both accepting deposits and underwriting securities, and led to segregation of investment banks from commercial banks. It was signed into law under a Roosevelt administration.

An investment bank is a financial institution that assists individuals, corporations and governments in raising capital by underwriting and/or acting as the client’s agent in the issuance of securities. An investment bank may also assist companies involved in mergers and acquisitions, and provide ancillary services such as market making, trading of derivatives, fixed income instruments, foreign exchange, commodities, and equity securities.

Compared to retail banking which only involves the receipt of deposits and then lending out the proceeds as personal loans and mortgages, investment banking is much riskier.

The Gramm–Leach–Bliley Act in 1999 repealed many provisions of the Glass-Steagall Act of 1933, under the Clinton administration.  It effectively removed the separation that previously existed between investment banking which issued securities and commercial banks which accepted deposits. The deregulation also removed conflict of interest prohibitions between investment bankers serving as officers of commercial banks.

Some argue that these reforms contributed greatly to the Global Financial Crisis (GFC) that began in 2007 and has yet to end.

In the US there have been a number of bills put forward to re-enact the Glass-Steagall Act.

Yesterday, the UK government said it would comply with a recommendation by a Royal Commission investigating circumstances that led to the GFC, that investment banking operations should be completely separated from retail banking activities.

This debate is analogous to the regulation of alcohol trading.  In the 19th Century alcohol abuse was the scourge of Western society and memorialised by Charles Dickens.  It led to the Temperance Movement and in the US, they even succeeded in enacting legislation which resulted in the Prohibition.

A few decades later, a relatively dry generation has emerged that cannot recall the excesses of the past, and alcohol laws in New Zealand have been relaxed.  As a result, alcohol related deaths, alcoholism and fetal alcohol syndrome rates are gaining upward momentum once more.

Those who don’t know history are destined to repeat it.  — Edmund Burke (1729-1797),  a British Statesman and Philosopher who is often viewed as the philosophical founder of modern political conservatism.


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