Banks

I first entered the financial business in 1973 and at that time we learned about the Glass Steagall Act. This law was passed in the 1930’s to prevent banks from failing as they did during the Great Depression. Before that time banks had two separated functions, the first was the commercial bank that we are all familiar with and that is our local bank. The purpose of the local bank is to provide loans to citizens and businesses for things like cars and inventory. The second function was to sell new investment products to big investors, things like IPO’s, initial public offerings. This happens when a big company like 3M wants to sell a new issue of stock in order to raise money to expand. This new stock is sold by investment bankers to large volume investors.

During the depression years and before these dual purpose banks would have an IPO to sell and in addition to offering it to big investors they would sometime purchase some of the stock with the commercial banks money (depositors money) and when the IPO didn’t pan out they lost depositors money and sometimes went broke.

The passage of Glass Steagall was supposed to end this practice by breaking the bank into separate entities and this is where things were when I entered the business. Realize that this was still one big bank but they had separate areas for different types of business that is they were to separate commercial banking from investment banking.

The first thing I was introduced to in the area of banking was something called “The China Wall”. This was a mysterious invisible wall that separated the commercial people from the investment people. If I worked in the investment bank where I had access to the inner workings of a business I was not allowed to discuss this with someone who worked in the commercial side as it would be considered “insider information” and that would be illegal.

The way things worked was that I would schedule lunch at a certain restaurant at a certain time to discuss inside information but somehow one of my colleagues from the commercial side would be having lunch at the table next to mine where they would inadvertently overhear my conversation.

Since everyone in the industry knew what was going on it was no big deal to them when Clinton repealed Glass Steagall in 1999. Now we could discuss companies without sneaking around but this was deemed to be one of the main causes of the recent banking debacle so they have now introduced the “Volcker Rule” which is the modern day equivalent of Glass Steagall. What comes around goes around, and so I guess the secret lunches will be back in style. Now I feel much better.



John/Jack