Glass-Steagall

Because of the recent billion dollar loss at JP Morgan Bank, the push to get the Volker rule passed is in the new once again. Here is what I wrote about this a few months past. In the past I have discussed the “China Wall”. I started in the finance business in the early 70’s and one of the first oddities I encountered was the China Wall. This mythical wall was the result of the Glass-Steagall Act of 1933. Many banks have a commercial side that uses savings from depositors to make loans. Most of these loans are for business inventory, cars and some home mortgages. Banks also have an investment side that evaluates companies and helps them to sell stocks and bonds. Now the rub comes in when the banks use the profits they made on the commercial side to invest in the investment side. Glass-Steagall said that the commercial side is separated from the investment side by the invisible China Wall meaning that the investment people would not discuss business with the commercial side. Let’s suppose that I work in the investment side and I am helping a company with a business plan so I have access to inside information. I see that they have just developed a new product which is going to make them a lot of money. I arrange a lunch meeting with the CEO and just by accident a member of the commercial side is sitting at the table next to us. This person overhears our conversation and then goes back to the bank and using profits from the commercial side purchases a large amount of stock in the company I am helping. The China Wall has been breached. This sort of thing was quite common so when Clinton did away with Glass-Steagall in 1999 it didn’t cause much of a stir to the people who really knew what was going on. Later this was blamed for the mortgage fiasco but in fact it had very little to do with it. In an attempt to look as if the government was doing something about this they brought in the Volker Rule which was somewhat similar to Glass. This is for show but can easily be by passed.