Politicians Vs. Bankers

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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 5,700—more than 25 percent of all the banks in the country—in 1932 alone. With each bank failure the hopes and security of hundreds or thousands of families failed too, and the psychology of depression deepened its grip on the land.

Meanwhile, the great Wall Street banks, which had ridden so high in the 1920s and were still financially sound despite the Depression, had seen their reputations sullied by revelations of wrongdoing during the boom years. With the advent of the New Deal, a subcommittee of the Senate Committee on Banking and Currency began holding hearings to investigate, in Roosevelt’s words, “all the ramifications of bad banking.” The subcommittee’s counsel, Ferdinand Pecora, took on the task with relish, at least with regard to the large banks.

What he found made headlines over and over. To give just one example out of dozens, he uncovered the actions of Albert H. Wiggin, who was president and chairman of the board of Chase National Bank (a forerunner of today’s Chase Manhattan) in the 1920s. From mid-September through mid-December of 1929, Wiggin shorted his bank’s stock to the extent of forty-two thousand shares. This was at the time perfectly legal, but of course it put his own interests 180 degrees around from those of the stockholders. To add insult to injury, he had taken out a large loan to finance the short sale from . . . Chase National Bank.

With many of the small country banks still deep in financial disarray and the great money-center banks deeply politically wounded by the Pecora hearings, Congress set about to write a new banking law to put the system in order. And thus three men largely shaped the American financial landscape for decades.

President Roosevelt, an Eastern aristocrat with exquisitely sensitive political instincts but few ideological or economic convictions, had little use for the small-town bankers, most of whom were politically well connected with Congress and, outside the South, Republican. The President favored a national banking system that would effectively put these bankers and their financially weak but politically strong banks out of business.