Study Finds Glass-Steagall Act Merits Serious Reconsideration

Article excerpt

A half-century after the enactment of legislation that drove a wedge between commercial and investment banking in the United States, a research project was initiated to evaluate the costs and benefits of the Glass-Steagall Act in the context of today's U.S. and global financial system. The findings point to the need for far-reaching reform as a matter of public policy.

The Glass-Steagall Act has fundamentally altered the competitive structure, conduct, and performance of the commercial and investment banking industries, as well as economies of scale and economies of scope among firms in the U.S. financial services sector.

The study suggests that competition in several segments of the investment banking industry today is not as vigorous as it might be, and that the new market participants that the securities affiliates of commercial banks would represent should enhance the degree of competition in corporate finance. Lower fees, better service, broader access, improved secondary markets, and greater innovation would be a likely result. It seems probable that the entry of affiliates of investment banks into commercial banking would likewise enhance competition and dynamism in that industry.

If deregulation is to be justified in economic terms, that justification must come in large part through substantive change in competitive performance in the provision of corporate financial services. There is already substantial competition between investment banks and commercial banks for a wide variety of such services, as well as in the international capital market.

In areas where there has been an absence of artificial barriers to competition, the degree of efficiency and innovativeness that characterizes the various competing financial services firms has been very high indeed, with commensurate benefits accruing directly to the users of the services and more broadly to the economic and financial system as a whole. Entry Artificially Restricted

In domestic underwriting and dealing in corporate securities, entry by potentially powerful new competitors has continued to be artificially restricted under the Glass-Steagall legislation. Economists generally work under the assumption that any such limitation of competitive opportunity favors those who benefit from protection, and reduces the efficiency with which financial and human resources are allocated -- the so-called static "deadweight losses" associated with protected markets.

There are also adverse dynamic consequences (such as reduced financial innovation) that make themselves felt over a period of time, and which ultimately are likely to be substantially more important. Evidence on the size and stability of underwriting fees, the quality of services provided to small issuers, and the underpricing of new issues seems to follow the pattern one would expect to see in a protected market. Comparisons between the markets in which banks compete (e.g., municipal general obligation bonds and Eurobonds) and those from which they are excluded (e.g., a large portion of the municipal revenue bond market and the domestic corporate securities market) reinforce this evidence.

The study's conclusion, that more competition is better than less, comes as no great surprise either from the standpoint of efficiency or fairness. It seems well justified in terms of the inferential evidence presented on concentration and competitive structure. Despite the fact that precise data are unavailable on the actual returns on financial (and human) resources used in underwriting and dealing in corporate securities, the evidence does suggest that statutory barriers generate costs, and that deregulation would generate material benefits to the users of corporate financial services and to the economy at large.

Moreover, the Glass-Steagall restrictions may additionally limit commercial bank access to the market for other investment banking services -- such as private placements, and mergers and acquistions -- in which they are indeed allowed to compete. …