Will we ever see a Glass-Steagall redux?

What do Salomon Brothers, First Boston, Bear Stearns, Lehman Brothers and Merrill Lynch all have in common?

– storied brand name

– loyal client base

– fiesty and independent employee culture / reputation

– global reach

– multiple product lines, with revenue sources often dominated by the “flavour of the month”

Two decades ago, these were some of the strongest names on Wall Street. Today, none of them are independent, and some are out of business. They also share the lack of what’s known in the financial services world as a deposit base; which means they can be, at times, at the mercy of the short term funding market.

The competitive disadvantage this provides is stark, as we’ve seen over the weekend.

When the “four pillars” fell a few years ago in Canada, and the Glass-Steagall Act was set aside in the U.S. by Congress and then President Clinton, the trend towards the financial monolith began in earnest. Commercial banks could now play in investment banking, and attempt to cross-sell their lending products (without being seen to tie the two together). A few U.S. commercial banks acquired various mid-tier franchises in the hopes that the “buy versus build” strategy. In Canada, Dominion Securities, Richardson Greenshields, Nesbitt Thomson, Burns Fry, McLeod Yound Weir did the trick for the Canadian banking fraternity.

What we are seeing in 2008 is, in part, a byproduct of the repeal of Glass-Steagall. Sure, dumb decisions are coming home to roost. But the fact that certain institutions are more likely to survive the worst crisis in the financial industry since 1929 appears to be directly tied to whether or not they have a decent retail banking franchise.

A hedge fund might have worried about having money on deposit at Lehman last week, for fear that under a bankruptcy / workout scenario they would have a hard time getting at their capital for a period of time. The solution? Move the cash somewhere else.

For a retail customer of a commercial bank, the governments of Canada and the U.S.A. have a safety net in place called deposit insurance. Which doesn’t mean that people don’t get nervous about a “run on their bank”, but the fear of personal financial loss is perhaps more remote on an individual’s list of daily worries. As such, most retail customers don’t move their deposits around based upon the daily share price move of the bank in question. A stability that publicly-traded U.S. independent investment banks lack (think ABCP here at home).

As the tide for “more regulation of Wall Street” rises in the U.S. House of Representatives, one has to wonder what the knee jerk reaction to this mess will be. Congressional Representatives could care less about the plight of individual investment banks, but they are dearly concerned about what becomes of the local banks in their district. So many of the so-called “toxic” products that are weighing on the balance sheets of the commercial banks were manufactured by the i-banks of the world, which might suggest that Congress will want to see something “big” come of all this. Could that be a return to the separation of the two lines of business: commercial banking from investment banking?

I don’t think we’ll ever see it go that far, but Main Street will be going to the polls in November. The line “the system is working itself out” won’t carry many votes.

MRM