Banking partition proposed

Senators look at reviving 1933 law

— Seeking to prevent future financial crises and soothe public anger over bailouts and bonuses, lawmakers in both parties are proposing legislation similar to the 1933 Glass-Steagall Act that separated commercial and investment banking.

A one-page proposal, gaining traction in Congress, could turn back the clock on Wall Street 10 years, forcing the breakup of banks, including Citigroup Inc., analysts say.

“The impact on Wall Street would be severe,” said Wayne Abernathy, an executive vice president at the American Bankers Association.

Some Wall Street executives endorse such a split.

“What we need is a 21stcentury Glass-Steagall,” said Gerald Rosenfeld, deputy chairman of Rothschild North America Inc. and a professor of business and law at New York University.

The wall dividing commercial and investment banks came down with passage of the Gramm-Leach-Bliley Act of 1999.

The proposal to rebuild the wall, made on Dec. 16 by Republican Sen. John Mc-Cain of Arizona and Democratic Sen. Maria Cantwell of Washington, would prevent deposit-taking banks from underwriting securities, engaging in proprietary trading, selling insurance orowning retail brokerages. The bill could also force the unwinding of deals consummated during the financial crisis, including Bank of America Corp.’s acquisition of Merrill Lynch & Co.

Resurrecting Glass-Stea-gall goes beyond the array of new regulatory powers that President Barack Obama has proposed to fix the financial system. It has also sparked debate among academics, regulators and legislators over whether Glass-Steagall could have prevented the crisis of 2008 or might help avoid future ones.

Splitting the banking functions that are needed for the smooth operation of the economy from riskier securities and trading activities was proposed by the Group of Thirty, a nonprofit organization made up of former government officials and bankers, including Paul Volcker, a former Fed chairman and head of the president’s Economic Recovery Advisory Board.

The group said the crisis spread like a contagion from firm to firm, putting both commercial banks and securities companies at risk. To prevent a domino effect, systemically important financial institutions shouldn’t be allowed to engage in proprietary trading that involves “particularly high risks” or “serious conflicts of interest,” the group said.

H. Rodgin Cohen, chairman of New York-based law firm Sullivan & Cromwell LLP, who represented one side or the other in more than a dozen transactions stemming from the financial crisis last year, said the law wouldn’t have saved Bear Stearns Cos. or Lehman Brothers Holdings Inc. from collapse. And the government would not have been able to enlist JPMorgan Chase & Co. to take on the assets of Bear Stearns or allow Goldman Sachs Group Inc. and Morgan Stanley to become bank-holding companies, giving them access to the Federal Reserve’s discount window.

“If you look at what happened, with or without Glass-Steagall, it would have made no difference,” said Cohen.

The McCain-Cantwell proposal, which has picked up four additional co-sponsors, could be considered by the Senate Banking Committee as early as January, if Sen. Christopher Dodd, the Democratic chairman from Connecticut, and other members complete negotiations on a financial overhaul bill.

A similar bill has been introduced in the U.S. House of Representatives by Maurice Hinchey, a Democrat from New York. The House already adopted a measure on Dec. 11 to revamp financial regulation without Hinchey’s proposal.The chief sponsor of the overhaul measure, Rep. Barney Frank, has said he supports giving regulators the power to apply Glass-Steagall in individual cases.

One reason support for the idea is growing is that lawmakers see public anger building over what Obama called “fat-cat bankers.” As industry profits bounce back and banks repay Troubled Asset Relief Program funds - and also get set to hand out billions of dollars in bonuses - Americans are still struggling with a 10 percent unemployment rate and home foreclosures. That’s leading Congress to seek ways to rein in the firms blamed for the financial crisis.

“Congress is at war with Wall Street,” said former Fed Gov. Lyle Gramley, now a senior economic adviser at Soleil Securities Corp. in New York. “They perceive Wall Street as being the root source of our financial crisis, and they want to do something to make sure that doesn’t happen again.”

The financial system has “failed the test of the marketplace,” Volcker said in January. He added that “it’s been proven that they’re unmanageable, the existing conglomerates.”

Some executives who support new regulations are guided by the principle that smaller is better. Christopher Whalen, managing director of Institutional Risk Analytics, a Torrance, Calif., firm that evaluates banks for investors, said the repeal of Glass-Steagall in 1999 was based on a false premise that bigger banks would be more competitive and efficient.

“I don’t think there are any efficiencies of scale in banking,” Whalen said. “Making them smaller would be far more efficient and also improve competition. If we had broken up Citi last year, we would have seen a couple of new market entrants buying operations. That is what creative destruction is all about.”

Bank lobbyists are targeting the Senate Banking Committee as lawmakers negotiate provisions of a regulatory overhaul bill. They’re arguing that a return to the pre-1999 era would reduce the diversity of revenue streams, make financial firms more vulnerable in a crisis, prevent them from acquiring ailing institutions, increase the cost of raising capital and undermine the global competitiveness of U.S. institutions.

“Reinstating Glass-Steagall misses the mark - a point we intend to share with Chairman Dodd and other senators on the committee,” said Rob Nichols, president of the Financial Services Forum, a Washington-based trade group that represents the chief executive officers of the largest financial firms.

Dodd said he doesn’t favor reviving Glass-Steagall as a way of dealing with “toobig-to-fail” institutions saying “there are other things we can do to break them up.”

Also lining up on the side of the banks are two sponsors of the 1999 bill that dismantled Glass-Steagall: Jim Leach, a former Republican congressman from Iowa, and Phil Gramm, a former Republican senator from Texas. Gramm said that, rather than weakening banks, the law cushioned the impact of the subprime-mortgage crisis by making financial institutions more broad-based and competitive.

“A lot of this is about trying to find somebody to blame,” said Gramm, now a vice chairman of investment banking at UBS Securities LLC.

Front Section, Pages 1 on 12/29/2009

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