THE SEPARATION OF COMMERCIAL AND INVESTMENT BANKING The Glass-Steagall Act Revisited and Reconsidered

THE SEPARATION OF COMMERCIAL AND INVESTMENT BANKING The Glass-Steagall Act Revisited and Reconsidered

STUDIES IN BANKING AND INTERNATIONAL FINANCE Published by Macmillan in association with the Department of Banking and Finance, City University Business School, London General Editor: Geoffrey E. Wood Roy A. Batchelor and Geoffrey E. Wood (editors) EXCHANGE RATE POLICY George J. Benston THE SEPARATION OF COMMERCIAL AND INVESTMENT BANKING: The Glass-Steagall Act Revisited and Reconsidered Forrest Capie and Geoffrey E. Wood (editors) FINANCIAL CRISES AND THE WORLD BANKING SYSTEM FREE BANKING AND PRIVATE MONEY INTERWAR MONETARY EXPERIENCE MONETARY ECONOMICS IN THE 19805 UNREGULATED BANKING: Chaos or Order? Brian Griffiths and Geoffrey E. Wood (editors) MONETARISM IN THE UNITED KINGDOM MONETARY TARGETS Donald R. Hodgman and Geoffrey E. Wood (editors) MACROECONOMIC POLICY AND ECONOMIC INTERDEPENDENCE MONETARY AND EXCHANGE RATE POLICY Kate Phylaktis and Mahmoud Pradhan (editors) INTERNATIONAL FINANCE AND THE LESS DEVELOPED COUNTRIES Zannis Res and Sima Motamen (editors) INTERNATIONAL DEBT AND CENTRAL BANKING IN THE 19805 Series Standing Order If you would like to receive future titles in this series as they are published, you can make use of our standing order facility. To place a standing order please contact your bookseller or, in case of difficulty, write to us at the address below with your name and address and the name of the series. Please state with which t i tyou l ~ wish to begin your standing order. (If you live outside the United Kingdom we may not have the rights for your area, in which case we will forward your order to the publisher concerned.) Customer Services Department, Macmillan Distribution Ltd, Houndmills, Basingstoke, Hampshire, RG21 2XS, England.

The Separation of Commercial and Investment Banking The Glass-Steagall Act Revisited and Reconsidered George J. Benston John H. Harland Professor of Finance, Accounting and Economics Emory University, Atlanta, Georgia M in MACMILLAN association with the Palgrave Macmillan

George J. Benston 1990 Softcover reprint of the hardcover 1st edition 1990 978-0-333-51576-1 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 33-4 Alfred Place, London WClE 7DP. Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages. First published 1990 Published by THE MACMILLAN PRESS LTD Houndmills, Basingstoke, Hampshire RG21 2XS and London Companies and representatives throughout the world Phototypeset by Input Typesetting Ltd, London British Library Cataloguing in Publication Data Benston, George J. (George James) The separation of commercial and investment banking: the Glass-Steagall Act revisited and reconsidered - (Studies in banking and international finance). 1. United States. Commercial banking I. Title II. City University, Department of Banking and Finance III. Series 332.12'0973 ISBN 978-1-349-11282-1 ISBN 978-1-349-11280-7 (ebook) DOI 10.1007/978-1-349-11280-7

To my wife, Alice: my love, best friend, and teacher - my emotional and intellectual partner

Acknowledgements: Peter Aranson, Roger Mehle, Thomas Huertas, Brian Gendreau, and George Kauf were most generous with incisive criticism and valuable suggestions, for which they deserve great thanks and no blame for what remains.

Contents List of Tables x 1 Introduction 1 I A Very Brief History of the Act 1 II A Brief History and Overview of the Book 3 III The Provisions of the Glass-Steagall Act 6 IV The Generally Accepted Rationale for the Separation of Commercial and Investment Banking 10 V Summary of the Rationale for the Legislation and Outline of the Present Inquiry 13 2 Sources and Contents of Information: Pre-Glass-Steagall 15 3 Evidence on the Risk of Losses 20 I Allegations of Risks Caused by Banks' Securities Operations 20 II Speculations About Risks Listed in Part 7, Chapter IV of the Glass Subcommittee Hearings 23 III Evidence on Risks Given in the Glass Subcommittee Hearings 27 IV The Failure of the Bank of United States 29 V Failures of Banks that Conducted Securities Operations Compared with Other Banks 32 VI Securities Affiliates and the Securities Holdings and Consequent Failure of Allied or Other Banks 34 VII Conclusions 41 4 Conflicts of Interest and Abuses 43 I Sources of Data 43 II General and Often Incorrect and Misleading Allegations of Conflicts of Interest and Abuses 44 III The Charges Against National City Bank and Mitchell 47 IV The Charges Against Chase National Bank and Wiggin 76 V Unloading Excess or Bad Securities on Bank Trust Departments by Securities Affiliates 89 vii

viii Contents VI Conflicts of Interest and Abuse By and Through Commercial Bank-Sponsored Trusts and Investment Companies 92 VII Summary and Conclusions 106 Appendix - Allegations Not Relevant to Glass-Steagall 108 1 National City Bank and Company and Mitchell 108 2 Wiggin of Chase National Bank and Chase Securities Corporation 113 3 Conclusions 121 5 Securities Services: Improper Banking 123 I Senator Bulkley's Conception of The Proper Role of Commercial Banking 123 II The Performance of Securities Underwritten by Bank Affiliates 128 III Securities Underwritten by the National City Company 131 IV The Performance of Commercial-Bank-Sponsored Investment Trusts, Companies, and Funds 132 V Conclusions 133 6 Restraints on Competition and Political Necessity as Explanations 134 7 Commercial Banks' Federal 'Safety Net' 139 I Federal Deposit Insurance 139 II Federal Reserve Bank Discount Window Loans 142 III Federal Reserve Intervention to Prevent a Banking System Crisis or Failure 143 IV Government Intervention to Prevent Disruptions Due to the Failure of Financial Service Firms Generally 144 V The Additional Risk or Risk Reduction of Banks' Securities Activities 145 VI Evidence on the Risk of Combining Commercial and Investment Banking 149 VII Methods of Constraining Excessive Risk-Taking by Banks 159 VIII Summary and Conclusions 161

Contents ix 8 Concern for Unfair Competition 163 I Lower Cost of Funds (including Underpriced Deposit Insurance and the Protection of the Federal 'Safety Net') 165 II Tax Deductibility of Carrying Costs 167 III Captive Markets 168 IV Unequal Powers - Commercial v. Investment Banking 170 9 Concentration of Power and Performance 173 I Pre-Glass-Steagall Act 173 II Current Concerns about Securities Underwriting 173 III Current Concerns About Commercial Bank Trusts and Corporate Equities 177 IV Conclusions 178 10 Universal Banking 179 I Imputed Advantages and Disadvantages of Universal Compared to Specialised Banking 179 II Summary and Overall Conclusions 212 11 Other Reasons for Glass-Steagall 215 I Senator Glass's Beliefs 216 II The Failure of the Bank of United States 217 III The 1930s Banking Crisis 218 IV Mis-statements by Senator Glass and Damaging Publicity from the Pecora Hearings 220 V The Self-Interest of Many Commercial and Investment Bankers 221 Appendix: Securities Activities of Banking Organizations Permissible Under Federal Law 223 Bibliography 245 Index 253

List of Tables 4.1 Trading accounts in which Chase Securities Corporation participated other than trading accounts operated in connection with securities offerings (1923-32) 84 4.2 Transactions in the shares of Chase National Bank and Chase Securities Corporation Stock participated in by the Chase Securities Corporation and Metpotan Securities Corporation 87 x