Would Dividing Commerical and Investment Functions Be Enough to Prevent Risky Behavior?

BY busadmin  January 22, 2010 at 11:13 AM EDT

Question: Since our largest banks became large by joining together many regional banks and became rich enough to practically own Congress, it seems to me we should take them apart for our own safety, and divide commercial from investment functions so that one corporate entity does not have both. Would this be enough to keep down risky investment processes?

Paul Solman: Not necessarily. In the 1930s, literally THOUSANDS of banks failed and almost all of them were small, yet we still had a doozy of a banking crisis Then there was the savings and loan crisis of the 1980s, caused by the eponymous “savings and loans.” Some were pretty big, like Arizona Charles Keating’s famous Lincoln Savings and Loan, but none were too big to fail, which is why so many of them did.

No, as FOBD* professor Zvi Bodie, Boston University’s pension guru, has long pointed out, a nation of small banks, if they all take the same outsized risks and make same big-time mistakes, can face a banking crisis without ANY banks that are too big to fail. But if we were to become a nation of smaller banks, at least we wouldn’t have to bail out specific institutions just because they’re large, wouldn’t be encouraging their over-the-top risk-taking with an implicit government guarantee. That, in theory, should make the system more stable.

*Friend Of the Business Desk