Sandy Weill Calls for the Return of Glass-Steagall

An extremely ironic thing happened this week. On CNBC's Squawk Box, the 79-year-old former chairman and CEO of Citigroup (NYS: C) , Sandy Weill, endorsed breaking up the nation's largest banks -- in addition to Citigroup, he was presumably referring to JPMorgan Chase (NYS: JPM) and Bank of America (NYS: BAC) , among others.

"What we should probably do is go and split up investment banking from banking," Weill said. "Have banks be deposit takers, have banks make commercial loans and real estate loans, have banks do something that's not going to risk the taxpayer dollars, that's not too big to fail." In effect, Weill was calling for a reimposition of the Glass-Steagall Act -- the Depression-era legislation that for 66 years forbade the commingling of investment and commercial banking.

The irony comes from the fact that Weill was the chief architect of Glass-Steagall's repeal in 1999. The year before, Weill had orchestrated the megamerger between Citicorp, a traditional Wall Street bank, and Weill's Travelers Group, a financial conglomerate with concerns in insurance, brokerage, and investment banking. According to Weill at the time, the act's presumed prohibition of the merger was "archaic" and needed to go. It's said that Weill himself even called President Clinton the night before the act's repeal to personally lobby for its demise.

Now, truth be told, while I can't help agreeing with his point, I also can't help wondering what motivated the change of heart. Why now? Why not 10 years ago? Is he eager to get back into banking? Did he miss the national spotlight? Or, dare I ask, is he trying to exact some revenge on his erstwhile protege, Jamie Dimon? It's impossible to say.

What isn't impossible to say is that breaking up the "too big to fail" banks in an orderly manner would move our financial system one step closer to regaining the confidence of investors here and abroad.

Rome wasn't built in a day
To be fair, as my colleague Michael Lewis reminds us, breaking up the banks isn't alone a panacea for future crises or, for that matter, past crises. Michael points to the facts that Bear Stearns and Lehman Brothers were solely investment banks at the time they collapsed, Merrill Lynch only became entangled with Bank of America once the crisis had metastasized, and the biggest recipient of bailout money was an insurance company -- though one could argue that AIG (NYS: AIG) was merely a conduit for its counterparties like Goldman Sachs (NYS: GS) .

But Rome wasn't built in a day, and neither is a competent regulatory infrastructure. Congress worked for years to remedy the failures that caused the Panic of 1929 and ensuing Depression. And what they finally put into place, from the Securities Act of 1933 to the Investment Company Act of 1940, served as the backbone of our capital markets for more than half a century.

That is, until it started to be torn down in the deregulatory fervor of the 1980s and continued -- undisturbed by its progeny, the savings-and-loan crisis -- until four years ago. In 1998, for instance, as I've noted before, Alan Greenspan, then chairman of the Federal Reserve, prevented the Commodities and Futures Trading Commission from regulating a particular type of derivatives known as swaps that would ultimately bring down AIG and play a major role in the 2008 financial crisis. Doing so was "unnecessary," according to Greenspan, because "participants in financial futures markets are predominantly professionals that simply do not require the customer protections that may be needed by the general public." Talk about famous last words.

To get back to the point, acknowledging that the Glass-Steagall Act wouldn't have pre-empted the most recent crisis isn't the same thing as saying that it shouldn't be reinstated. That's throwing the baby out with the bathwater, as its perceived impotence stems rather from the fact that it's only one of many prescriptions necessary to cure a much broader ailment. To steal a phrase from my brilliant colleague Morgan Housel, the financial industry has simply become too big for its britches.

The heart of the matter
It's to be expected that wealthy bankers with vested interests like Jamie Dimon of JPMorgan Chase will squeal about prudent regulatory safeguards like the Volcker Rule, which bans bankers from gambling with the money in your savings account. But the reality is that this type of activity offers little to no value to anyone beyond the bankers themselves. As Federal Reserve Governor Sarah Raskin recently put it, "I view proprietary trading as an activity of low or no real economic value that should not be part of any banking model that has an implicit government backstop."

And the same thing can be said about the marriage of investment banks and traditional banks. The function of a traditional bank is simple: to allocate capital between borrowers who wish to engage in economically productive activities, such as starting a business or purchasing a home, and depositors who have funds that are otherwise sitting idle. We've deemed this function so valuable, in fact, that we as taxpayers have even assumed the risk of loss by federally insuring depositors. Alternatively, a model that's predicated instead on the fancy buzzwords of investment banking -- market-making, equity underwriting, proprietary trading, and the like -- ignores this core function. And as a result, the latter model shouldn't be entitled to the same type of preferential treatment as traditional banks merely because they're under the same corporate umbrella.

A Fool's take
I can't help applauding Weill's decision to renounce the crowning achievement of his career. For once, maybe even he's looking out for something other than his own net worth -- though I won't truly believe it until he calls the president.

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