Lehman’s Failure Marks The End Of A Banking Era

Aside from signaling the finish of a time for Lehman Brothers and Merrill Lynch, this weekend’s activity definitively drew a line at the end of another historical period: the Age of Glass-Steagall. The Glass-Steagall Act is the Depression-era law that separated commercial and investment bank. It was functionally repealed in 1998, when Travelers (the parent company of Salomon Smith Barney) obtained Citicorp.

Glass-Steagall was one of the many necessary measures used by Franklin Delano Roosevelt and the Democratic Congress to deal with the Great Depression. Crudely speaking, in the 1920s commercial banks (the types that took debris, made construction loans, etc.) plunged in to the bull market recklessly, making margin loans, underwriting new issues and investment private pools, and stock trading.

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When the bubble popped in 1929, contact with Wall Street helped move down the commercial banks. In the lack of deposit insurance and other backstops, the total results were damaging. Wall Street’s failure helped destroy Main Street. The policy response was to erect a wall structure between investment banking and commercial bank.

It outlasted the Berlin Wall by a few years. In the 1990s, as another bull market had taken hold, momentum created to overturn Glass-Steagall. Commercial banks were eager to get into high-margin businesses like underwriting hot tech stocks. Brokerage firms saw commercial banks, with their massive customer bases, as great distribution channels for stocks, mutual funds, and other financial loans that they created. Speaking Generally, the investment banks were the aggressors. In April 1998, Sandy Weill’s Travelers, which owned Salomon Smith Barney, merged with Citicorp. The following year, Congress transferred and President Clinton agreed upon the Financial Services Modernization Act of 1999, known as the Gramm-Leach-Bliley Act.

This legislation effectively deleted the prohibition on commercial banks owning investment banks and vice versa. Since that time, the two sectors have come to a qualification jointly. And generally, the investment banks, which weren’t at the mercy of regulation by the Federal Reserve and didn’t have to adhere to stodgy capital requirements, have been the alpha dogs.

In 2000, the investment bank company J.P. Morgan bought commercial bank or investment company Chase. Up until the summertime of 2007, the debt-powered indie broker-dealers who minted money with stock brokering, proprietary trading, and advising on acquisitions and mergers appeared arranged to leave boring commercial-banks in their dust. But 2008 has been another story.

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