Break up the Banks!

By: James Walsh- Business Instructor- Online Division

Sanford “Sandy” Weil, dealmaker and builder of the megabank Citicorp recently shocked an audience on a cable TV Network by calling for a split up of the big banks.
Mr. Weil reignited a debate that still simmers beneath the surface, the issue of just what kind of banking system best serves the interests of the U.S. economy.

You see, banks engage in two types of activity. One is the main street banking we all know. We deposit our paychecks there; have checking accounts and credit cards with them. And most importantly they make loans to us for things like buying houses and cars, crucial activities for a functioning economy.  But Banks also engage in other Investment activities like securities trading. That can involve high risk instruments like derivatives and CDO’s  They can be spectacularly profitable activities when they make the right call, and run up spectacular losses when they are wrong. In ’08 when they were spectacularly wrong, taxpayers had to bail them out or see the entire bank go under.

There is a way to do this better say Mr.Weil and others, by splitting up the banks two major activities. The main street bank would do main street things and be regulated by the Federal Reserve. Depositors would enjoy protections under the FDIC. The Investment part of the bank would be broken off, and allowed to sink or swim on its own and no taxpayer bailout if they make bad calls!

Now all we need is our gridlocked political system to apply the fix. Throw in a large dose of dollars from the powerful banking lobby and real reform has never gotten off the ground in Washington. But at least people like Sandy Weil will not let us forget the large risk we take by our inaction.

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One Response to Break up the Banks!

  1. Chelsea Parkinson says:

    In a way though, this also ignores another key feature of “main street” banking activities: lending.

    Deposit services are only free if there is sufficient loan volume or investment income to subsidize them. Consumers receive interest on their funds because of the use of those funds. And remember, the primary culprit in the securities collapse (to my understanding) were mortgage-backed securities, securities comprised of bundled substandard mortgage LOANS.

    Some financial institution made those loans in order for the loans to so be packaged into a security. If the loan remained on the financial institution’s balance sheet, it still would have gone “bad”, and the bank or other institution would still have taken the loss and transferred the loss to consumers.

    To ignore the lending factor of banking (credit risk being a constant risk all financial institution’s with lending capacity must face) seems to be a narrow view, and to separate the investment portion will not alleviate credit risk loss. Investments may carry credit risk, but so too will loans. Only the individual balance sheet review will determine which asset carries greater risk, and to pass sweeping legislation that separates the two asset management components seems unlikely to accomplish the desired outcome.

    Furthermore, credit risk is a necessary facet of business both to service customers of more modest means and to simply “keep the wheels turning”. Zero credit risk implies no loans whatsoever, and then all consumers will pay the price (debit card fees, checking account fees, and other costs for services that are now necessary in our largely cash free electronic world) for our pain and risk aversion.

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