Monday, May 14, 2012

BREAK UP THE BANKS? ARE YOU SURE?

BANKS & THE ORDINARY INVESTOR

I rarely write articles on this blog that are not related to my major focus of investing for income.  But I decided to post my view of the investment bank issues brought up, again, by the trading mistakes of JP Morgan.

The “Banking Act of 1933” is important to understand if you think our banks are too big to manage.  If you would like to read the act in detail a link is provided.


The act is better known by the name “Glass-Steagall” which uses the names of the senator and representative who authored the act.   The link below describes the four sections of the Banking Act of 1933 that are most relevant to understanding how the separation of commercial and investment banking were addressed in the Banking Act.


The Glass-Steagall Act consisted of four provisions to address the conflicts of interest that the Congress concluded had helped trigger the 1929 crash:[1]
·         Section 16 restricted commercial national banks from engaging in most investment banking activities;
·         Section 21 prohibited investment banks from engaging in any commercial banking activities;
·         Section 20 prohibited any Federal Reserve-member bank from affiliating with an investment bank or other company “engaged principally” in securities trading;
·         Section 32 prohibited individuals from serving simultaneously with a commercial bank and an investment bank as a director, officer, employee, or principal.
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Students interested in the potential breakup of megabanks, can learn a lot from the following website.   http://www.fdic.gov/bank/analytical/firstfifty/chapter3.html.

TheMoneyMadam’s view of the situation.

Personally, I am in favor of separating commercial and investment banks.  I am not one in the group that hates banks.  Banks are absolutely necessary for free market capitalism to work its magic.  If investment banks want to make big bets, it is okay with me as long as my only risk is if I own the stock of that bank.  I do not want my deposits to be at risk.

Saving for a rainy day and knowing that the money you saved will be there when you need it, is also absolutely necessary for the ordinary investor to have confidence in the financial system.  If the ordinary investor choses to own the common stock of a bank, then you assume the same risk just as you would with an investment  in any stock.  But if the investment bank cannot use your deposits for their big bets, you can rest well knowing your emergency funds are available when you need it.

You know in 1933 the big stock market crash was already four years old.   Moreover, the country had been through multiple major financial crashes.   This suggests the finance professionals had a lot of history to call upon when they created Glass-Steagall.   One of the purposes of this 53 page act formally named the “Banking Act of 1933” was to make sure our deposits were safe.   The act not only separated the commercial and investment banks, it created depositor insurance.

While the separation of commercial and industrial banks has been repealed, the deposit insurance remains in place but there is trouble in river city.   The insurance fund is stressed because the mega banks have done what all organizations do, they made mistakes.  Since the insurance fund applies to these mega investment banks our deposits are again at risk.

I believe the separation of commercial and investment banks can again be implemented and it will be easier this time because we have the lessons of history to help us and we already have the insurance system in place.   This separation will allow for improved safety of our deposits.
Some regulations are better than others and this is one I fully support.

Very Truly Yours,

TheMoneyMadam

Later this week I will profile our next dividend machine.   Stay in touch!
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