Has Anyone Seen Glass Or Steagall?

By Gregory S. Davis | September 18, 2008 AAA

The lines between commercial banking and investment banking have moved from blurry to nearly invisible. The Glass-Steagall Act (GSA), instituted in 1933 to separate the coexistence of commercial and investment banking, was repealed in 1999 leading to the creation of universal banks like Citigroup (NYSE:C) and Bank of America (NYSE:BAC). The credit crisis and bad debt weighing down the economy has further accelerated the consolidation of financial institutions into a select few. Investors should be aware of how past legislation is having an impact on today's market. (For a refresher course, see What Was The Glass Steagall Act?)

Universal Banks
The Gramm-Leach-Bliley Act of 1999, which repealed the GSA, rekindled competition among banks. It meant banks could once again offer investments, investment banking, commercial banking and insurance all under one roof. Bank of America and Citigroup were two of the main beneficiaries of this rule change. Merger & acquisition revenue that had been the domain of Wall Street elites like Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS) after GSA, opened up to the one-stop shop banks.

Does Bigger Equal Better?
The appeal of a one-stop shop for a company seeking M&A advice is to also have the ability to secure financing for liquidity or future deals. One danger for regular people who just want to make deposits and have a checking account is that these banks are in the position to leverage customer assets against risky investments like the Collateralized Debt Obligations (CDO). Between 2000 and 2007 Bank of America stock climbed 87%, but Citigroup, born of the merger of Citicorp bank and insurer the Travelers Group in April of 1998, saw it's stock price drop nearly 10% during the same period. The larger Citigroup struggled during the period and is struggling again today to convince investors that the combination of insurance, retail banking and investment banking could be managed successfully.

Citiesque
Bank of America is looking a lot like Citigroup after the announcement of its planned combination with Merrill Lynch (NYSE:MER). Merrill's 16,000+ financial advisors and its $1.6 trillion in client assets will give Bank of America a huge pool of assets from its new investment management business. Bank of America will also benefit from Merrill's strength in global debt underwriting, equity sales and M&A business.

Final Thoughts
Legislation seems to swing both ways. After times of crisis measures are taken to protect investors then after a cooling off period legislation is often reversed in the name of competition. Either way, Stegall is gone; universal banks are here, and the future question is whether or not they can thrive in a post-subprime, credit-constrained environment.

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