Break up the Banks. Uhm, Obviously?

Today, former Citigroup CEO Sandford I. Weill said on CNBC that he thought that investment and retail banking in the US need to be separated as they were before the repeal of Glass-Stegall in 1999.  The financial industry is in utter shock over such a suggestion given that in his time at Citigroup Weill helped build the company into a financial behemoth and one of the largest banks in the world.  The hypocrisy is obvious but once past that there is truth to what Weill says.

Sandy Weill during his CNBC interview.

The reality is that he’s right.  Investment and retail banking are entirely different industries with vastly different risk profiles.  Investment banks have the ability to use the deposits of their retail clients to make extremely risky bets that would be otherwise inappropriate to the common retail client who is looking mainly for safety of their principal.  While the benefit to this is that when these risky strategies work out with a lot more money on the line, there is a lot more money to be made.  The downside is that when these strategies fail, they fail spectacularly (see: AIG, Lehmen Brothers) and because they were made with retail deposits the Federal Deposit Insurance Corporation (aka, the US taxpayer) is on the hook for a portion of the losses.

The recourse is simple: bring back the separation of retail and investment banking as Weill suggests.  Let commercial banks make commercial loans that are appropriate for retail deposits and let the FDIC back those up.  Let investment bankers take their risks, but do it with deposits which are made under a clear understanding of the risk involved and without the taxpayer being liable for the losses.  Aaron Sorkin (via one of his characters) summed up beautifully the effects of Glass-Stegall on this week’s episode of The Newsroom:

“It helped lead to the largest sustained period of economic growth in US history.  A 60 year expansion of the middle class, the largest increase in productivity, and the largest increase in median income.  We also won World War II, put a man on the Moon, and a computer in everyone’s lap.”

Meanwhile, it took less than a decade for the marriage of commercial and retail banking to bring the world economy into global recession and to the brink of total collapse.  The truly astounding thing is not what Weill said but rather that he is the only one saying it.