“If you invest your tuppence wisely in the bank, safe and sound, Soon that tuppence, safely invested in the bank, will compound. And you’ll achieve that sense of conquest as your affluence expands In the hands of the directors who invest as propriety demands….” (Mr. Banks in Mary Poppins)

While the shape of the universe has dramatically changed as a result of Scott Brown’s victory in the Massachusetts Senate race, life in the capitol goes on. Democrats, while nursing their wounds and what appears to be a fatal blow to health care reform are now turning to bank reform. Attempting to tap into the anger that lifted him to office, President Obama is pictured as relishing the fight. It appears he would be disappointed if the banks don’t make a real tussle of the coming main event.

While recognizing that it is an election year, I am disappointed that the president has again allowed “attack” to prevail over a reasoned analysis first of the problem and has acted in “fire first aim later” fashion. While liberal pundits continue to describe the president as “brilliant,” I am beginning to think he is neither bright nor much beyond adolescence in his emotional development. Lack of rationality, hubris and self absorption is likely to lead him down the same path to defeat that he has now suffered in health care reform. As in health care reform, that will be a tragedy for the nation. Reform in both areas is needed.

In the latest of the President’s “it is us versus them” sleight of hands, the president has discovered that the rush to merge his administration championed for financial service companies in order to “save the republic” last year has a few unintended consequences. Among them are two tiers of national banking institutions with little distinction in the top tier between investment institutions and consumer banks. This leaves the top tier handful of banks with more than half the nation’s financial assets continuing to be as vulnerable as they were last year to putting the nation in a “save them or face disaster” mode that we have sworn we will not repeat.

Two days after “Bunker Hill,” (Scott Brown’s election) the president declared “Never again will the American taxpayer be held hostage by a bank that is too big to fail.” Adopting proposals by Paul Volker, former Chairman of The Federal Reserve under Presidents Carter and Reagan, the president is asking Congress to ban banks that participated in any way in federal bailout funds or are large enough to have direct access to Federal Reserve lending from investing in ventures for their own account at the same time they are investing for their bank customers. I will give him a bravo for that, but it doesn’t get at the primary problem of size.

Volker has long believed that separation of bank functions and investing functions needs to be re-instituted. If adopted this would be just another in a series of ad hoc proposals to be floated as trial balloons from the administration in recent weeks. The president has also recently proposed a "financial crisis responsibility fee," while at least one outside expert, John Bogle, the founder of The Vanguard Funds, has proposed reinstitution of Glass Steagall ‘s complete separation of banking institutions from investment institutions.

These proposals are only the latest to come from the administration including one to create a new super financial regulatory agency which the Chairman of the Senate Finance Committee has now disavowed. As can be expected, Wall Street and The financial markets have reacted negatively both to the unsettling regulatory proposals as well as the possibility that Chairman Bernanke might not be confirmed in his Chairmanship of the Federal Reserve after having acted so heroically last year in preventing our financial collapse.

Wall Street and our banking institutions do not exist in a vacuum. There is a lot of history to parse before we should attempt to tinker further with the mess that has already been created by our changing the regulation that kept us safe for seventy years after the depression. Wall Streeters will tell you that it kept us safe, but it wasn’t in the financial interest of the country to let so much business be done by foreign banking/investment entities that did not have our restrictive environment.

For well over half our population there is no understanding of just how far our financial services have been transformed in the last twenty-five years. For the formative time of my life, we lived in an environment where the banking universe stopped at the state line. Glass Steagall created a restriction on cross state border banking that kept our banks locally focused. The bank president lived in your community, served on local charitable and service boards and that is where the money stayed that his bank gave to bolster the community.

That has all changed. I can remember the president of National Savings and Trust in Washington DC telling me with a sorrowful face that the merger of his bank into Sun Trust and his retirement marked the end of charitable support coming from individuals who lived in the Washington area and were really knowledgeable regarding what needed the attention. Thereafter the decisions would be made on a corporate wide basis and the criteria forever altered. In this earlier era, mortgages were obtained from your local bank or, a decidedly depression era created entity, the depositor owned local, savings and loan. It provided loans for residential real estate, maintained savings accounts that were marginally higher paying than banks, and again its bank executives were pillars of the local economy.

What brought the change was foreign competition. Large banking institutions, particularly in Japan were aligned with significant corporate entities spanning several business sectors and developed a thirst that their huge capital base permitted to look beyond their nation’s borders for higher returns. They eventually turned their attention on acquiring assets in the United States and could assemble sums undreamed of by our banks, even those in New York and those that had allied separately incorporated relationships with banks across state lines. The responding pressure of our bankers ultimately brought a crack in the Glass-Steagall wall by permitting the aggregation of banks under holding companies that has evolved to the B of As, and Wells Fargos of today. Up through this period, however, non banking activity such as securities brokerage, insurance and investment banking remained solely the province of investment banking houses that did not have the protection of funds provided to depositors by FDIC.

I have written in the past about the importance of the Community Reinvestment Act and its emphasis on inner city investment and loans as well as the unhealthy effect of Freddie and Fannie in pushing consolidated loan paper, but the final brick in this story is the passage in 1999 of Gramm-Bliley. It gave birth to an insatiable hunger to merge investment and banking institutions and the ever expanding thirst for more innovative ways to expand the leverage of deposited funds to raise bank income.

Given a clear field, the computer and the bright minds on Wall Street, and abetted by lax regulation in DC, our economy became awash in new forms of investment paper and derivatives looking for ever more profit. No one was asking themselves, “Yes, I see that I can do this, but should I?” Along with this failure, add the lax enforcement of securities and antitrust law, and you have the stew that begat the pickle we are in with too many assets in the hands of too few.

While we need to restore balance to our system, it should not come by corralling a few institutions with a huge portion of our national assets and punishing them with a fee (it is a tax!) that will put them at a disadvantage internationally, nor should we permit a few institutions to be closely regulated by The Treasury Department to the disadvantage of the normal competitive forces in the economy. Balance will come by restoring the separation that previously existed between banks with depositor insured funds guaranteed by an agency of the U.S. government from other institutions that wish to seek the higher returns available by being purely an investment house. That is their role. They seek larger investment horizons with the surplus funds of its participants, and God bless them for their innovation and risk, but heavens don’t let them use my tax insured deposits. If they have their own depositor funds, they also should never be allowed to invest their own funds counter to the interest of their depositors, nor should they be allowed to become so large we cannot as a nation bear their collapse. _._

Copyright © 2010 by Robert E. Freer, Jr. All rights reserved

About the author: Robert E. Freer, Jr., is president of the Free Enterprise Foundation. He is also a professor at The Citadel and was selected in 2005 to be their first John S. Grinalds Leader in Residence and in 2009 to be their first BB&T Visiting Professor in Ethics and Free Enterprise Leadership. A regular contributor to the Mercury, Prof. Freer may be reached at Robert.freer@citadel.edu. If you would like him to appear before your group or organization to speak on any of the subjects about which he writes, please contact him at The Citadel. Copies of his earlier columns may be found at The Free Enterprise Foundation