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‘Ring Fencing’ Support in Congress Only Poses Glass-Steagall

March 19, 2017 (EIRNS)—According to a report from a Congressional Republican staffer, the bank regulation proposal "made this week by the FDIC" (i.e., by Federal Deposit Insurance Corporation vice-chair Thomas Hoenig on March 14) has quickly gained some Republican Party support. As a "repeal and replace Dodd-Frank," Hoenig’s ring fencing-modelled proposal for bank separation has appeal, especially among conservatives.

But this simply poses the question of Glass-Steagall to these and other Representatives. Hoenig proposed that bank holding companies be compelled to separate their securities units from their commercial banking units, capitalize and manage them separately, and lose any FDIC insurance or other Federal "safety net" protection of those securities units. He also proposed that a tangible capital ratio of 10% of all assets, including derivatives, be imposed on all banks in the Federal Reserve System.

But only 10 years ago, as the biggest Wall Street banks and financial firms began to enter a crash, events showed that this regulation strategy does not work. The biggest holding companies had gone from typically 100-200 subsidiaries in 1995, to the range of 2,500-3,500 subsidiaries each. Hundreds and hundreds were simply "special purpose vehicles" for securitization of debt instruments, many of them nothing but bundles of derivatives, "synthetic derivatives," etc.

These vehicles were, in fact, separately capitalized, partly because the big holding companies wanted to hide them "off the balance sheet" of the commercial bank—"the Enron method." But when a few, first of Bear-Stearns and then of Citigroup, started failing, in short order all were going to fail by contagion; and since they were all the same kinds of toxic junk, no amount of capitalization was enough once the crisis hit. Then the irresistible urge took over at the main holding companies, to take these units back "on-balance-sheet" and save them—with insured deposit funds. And then the banks themselves had to be bailed out by the trillions by the Treasury, Fed, and FDIC.

Glass-Steagall makes the separation total and irreversible, and in crisis, lets all the speculative units fail. That’s the point. The commercial banking system is protected, and national credit can fund economic recovery and development, not be thrown away by trillions on banks’ bad bets.