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Glass-Steagall's Repeal Returns to Haunt Wall Street

Posted on 10 Mar 2009

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A decade after the repeal of Glass-Steagall Act, which separated commercial banks from securities firms, its ghost has returned to haunt the financial industry.

Comments by Paul Volcker, the former Federal Reserve chief advising President Barack Obama, and Federal Deposit Insurance Corp. Chairman Sheila Bair in the past week suggest it will become more costly for banks to remain in some of the areas they were let into with Glass-Steagall’s 1999 repeal, analysts said.

“The capital-market rules are going to change,” Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York, said in a Bloomberg Television interview. For firms that remain banks, “it’s going to be much more difficult to trade in the illiquid parts of the market” beyond government and corporate bonds, and to borrow to finance investments, he said.

Hedge funds will increasingly take over business in riskier areas such as emerging-market and distressed securities, predicted Hintz, who served as chief financial officer of Lehman Brothers Holdings Inc. from 1996 to 1998.

By removing the barrier between everyday banking such as lending and deposit-taking and riskier areas such as derivatives trading, Glass-Steagall’s 1999 repeal helped create the current crisis, according to some policy makers and politicians.

“You can’t break the bank and lose everyone’s” pension investments “without expecting a real food fight with respect to laying blame and trying to fix the financial system so this never happens again,” said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York.

Volcker called for a “two-tier” financial system that would limit risk-taking by the most systemically important firms, at a conference in New York March 6. Bair said in an interview with CBS that aired March 8 that Congress should curtail the size of the biggest banks.

Fed Chairman Ben S. Bernanke today said the central bank has already stepped up surveillance of the systemically important firms, and that such companies require “especially close oversight.” He spoke at the Council on Foreign Relations in Washington. Many on Wall Street are now resigned to jettisoning some sources of revenue and paring back others in order to comply with a new regulatory regime. How that regime will look around the world is set to be discussed when finance ministers and central bankers from the Group of 20 nations meet this week near London before an April 2 summit of leaders.