It’s the debate of the moment in the Democratic Party today. The Glass-Steagall Act which separated commercial and investment banking went from being something no one was against from 1933-1999, then something no one was for circa 1999-2014, and now is finally part of a vigorous debate. On the one side is the “Break up the big banks!” call from the Sanders wing and on the other is the much smaller “Yes, but it’s way more complicated than that!” voice of the establishment, usually Hillary Clinton.

It was the hottest topic at the last Democratic Debate on 13 October and it continues today. Your stand on it probably identifies who you back for president as well as your status in the Democratic Party. But is it worth all the hoopla?

Call me a pale male establishment type, but this is not a good argument.

“You’re money’s not here … it’s in your house, and yours!”

Glass-Steagall is the common name for the Banking Reform Act of 1933, taken from its sponsors. It established a separation between commercial banks, which take deposits and make loans, and investment banks, which buy stocks and other investments.

The purpose of this separation has everything to do with the state of banking from the 1920s to 1933, not today. The huge stock market bubble of the 1920s was caused in large part by banks and other large sources of capital investing heavily in the stock market as it skyrocketed up in value. Bank failures, which really started before the stock market crash for a variety of reasons, accelerated when shares plummeted in 1929. The resulting bank panics reverberated across America, wiping out cash reserves.

This is the effect that put the Great in the Great Depression. Everyone, everywhere who should have had some capital to invest was desperately broke.

It’s hard to get past this image when nasty stuff keeps happening.

By 1999 the high-flying stock market made this rule seem antique for a lot of reasons. One of them was, indeed, that banks wanted to invest in the stock market that was reaching new heights. But it also seemed like an anachronism generally given the way electronic banking was starting to work. The fact that your local retail bank couldn’t offer you access to bigger markets put them at a comparative disadvantage.

It’s common to trace the rise of big, over-sized banks to the repeal of Glass-Steagall – and Barataria did as much back in 2011, predicting that a big debate over this effect would come shortly. Here is that debate, but it turns out that the desire to separate commercial banking – writing checks, etc – from stock investing has less to do with the size of banks than other forces at work.

Naw, I’m on a low-fat diet.

The argument in favor of a new separation goes along the lines of this: 2008 was a clear demonstration of the problem with a small number of banks controlling a large share of the money. If we learned anything from this it’s that institutions which are too big to fail are nothing more than an uncontrolled liability to taxpayers who were put on the hook for the disaster with the Toxic Asset Relief Program (TARP).

There are several problems with this analysis. The first is that there is nothing in Glass-Steagall that would have prevented the 2008 fall of Lehman Brothers. What failed was the mortgage rating and investing system, not banking. While it’s true that banks became larger from 1999 it had more to do with how terribly unprofitable commercial banking is and the desire to merge in order to survive.

Oooooouch!

There simply isn’t much money in cashing checks for people, unless you can tack on large fees. Small banks that try to do it well are swamped by larger banks that offer more branch locations, more services, et cetera. The size of banks has little to do with the blend of investment and commercial banking and a lot to do with consumer preference, as discussed in this SF Gate article from 1998.

The repeal of Glass-Steagall also did not put taxpayers on the hook for anything. The TARP funds of $617B went not just to banks but to insurer AIG ($68B), Auto companies ($80B) Government backed lenders Fannie Mae ($116B) & Freddie Mac ($71B) and housing and credit projects ($37B). Hundreds of banks shared $245B of the funds in the form of a loan, the largest going to Bank of American and Citigroup ($45B each). This money has all been repaid with interest.

With the implementation of the “Volcker Rule” part of Dodd-Frank in 2013, a partial separation between FDIC insured commercial operations and investment banking has been achieved. Banks are also subject to “stress tests” that determine how much risk they have taken on and if they need to be forced to shed some of it.

On a personal note, once this was passed my support for Glass-Steagall waned.

There’s always a fight. This one is more interesting.

Of course, there is a huge problem with a small number of banks controlling such a large share of deposits. And this is traditional Democratic issue, dating back to the time when Andrew Jackson destroyed the Bank of the United States and made it harder to operate across state lines, effectively eliminating any national banks.

But if Glass-Steagall isn’t the answer, what is?

A comprehensive plan for regulating the entire financial system needs to be devised. It has to include rating agencies (Standard & Poors, Moody’s) insurers (AIG, etc) investment banks (JP Morgan) and commercial banks at a minimum. It probably should also include credit unions – to encourage them while making sure that their rapid growth isn’t coming from unsafe practices – who are probably the best bet to simply replace commercial banking as a concept.

If only you look at the big banks, you may be missing the forest for the trees.

– Hillary Clinton, 13 October debate

Not everyone can do this.

Lastly, it probably should form a new agency outside of the Federal Reserve, which has done a terrible job, far too cozy with banks large and small.

Once a serious proposal for reform is put into place we can decide if a Glass-Steagall separation is desirable. It may yet be. But it is impossible to see how this would make banks significantly smaller than they are now or how it would have had anything to do with the fall of Lehman and the need for a TARP fund.

As an issue, this is a dead one for Democrats. We cannot put our faith in one panacea to cure the problems in banking that have been ignored for far too long. This is a complicated problem that will take a lot of work before we have a well crafted regulatory structure. The sooner we put the talk about Glass-Steagall behind us and get serious about the market forces that create large banks the sooner we can do something about it.