Politicians vs. Bankers (February/March 2000 | Volume: 51, Issue: 1)

Politicians vs. Bankers

AH article image

Authors: John Steele Gordon

Historic Era: Era 8: The Great Depression and World War II (1929-1945)

Historic Theme:

Subject:

February/March 2000 | Volume 51, Issue 1

 

Democracy is usually a slow and almost always a messy business. Not infrequently, good politics trumps good policy in the process. Such was the case with America’s main banking law until Friday, November 12, 1999, when President Clinton signed the Financial Services Modernization Act to replace it. The new legislation allows banks, insurance companies, and brokerage houses to compete with great freedom across state lines and merge with one another to form financial conglomerates. In ten years the bank at the corner will be as likely to be owned by Merrill Lynch or Aetna as by Chase Manhattan. It will be possible for a family to get only one monthly statement that covers its cash deposits, investments, life insurance, and other monetary assets.

The law that makes this new American financial world possible took decades to achieve, and there was much blood on the floor in Washington before it passed. Indeed, the bill is the most recent of nearly a dozen serious attempts to overhaul banking law since the last major change in the depths of the Great Depression, but it is the only one to make it all the way through.

When you think about it, that is a monument to the power of the status quo in a democracy. The large city banks and brokerage houses long pushed for change, but the small country banks and S&Ls naturally preferred things as they were in their protected local markets. And Thomas Jefferson’s hatred of banks and commerce still reverberated in the halls of Capitol Hill despite two hundred years of Industrial Revolution.

The banking law that was finally replaced, the Glass-Steagall Banking Act, was equally the product of a messy process, but not, for once, a slow one. In fact, it was only one of the last of many bills enacted during the so-called Hundred Days at the start of the New Deal.

While only time will tell whether politics trumped policy in the new banking act, there is no doubt that it did in the last one. Glass-Steagall greatly weakened the country’s strongest banks while protecting the weakest ones from market forces by maintaining restrictions on competition.

Few alive today are old enough to remember the American banking system before Glass-Steagall. There were already many large and powerful banks in the United States, including J.P. Morgan & Co., arguably the most powerful bank that has ever existed, but most American banks were little one-branch affairs located in small towns. In 1921, there were no fewer than 30,456 of them, more banks than in the rest of the world put together.

But small, one-branch banks are ipso facto weak banks. During the 1920s, when the apparent prosperity was confined largely to the cities, these small banks failed at a rate that averaged 550 a year. When the Great Depression struck, the failure rate rose sickeningly, to a terrifying 5700—more than 25 percent of all the banks in the country—in 1932 alone. With