Obama's Glass Ceiling

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After the underpants stain the financial markets caused these past two years, it's natural people want solutions to prevent its recurrence. President Obama is tapping into that angst with some tough-talking new bank regulations, proposals that are gaining support in surprising places, like, well, right here at The Motley Fool.

It's too bad the new rules won't do a thing to prevent future crises, and had they been in place beforehand, wouldn't have done a darn thing either to prevent the meltdown.

Ugh! A history lesson
Vacuum off the cobwebs of your high-school history lessons and you'll recall that the Glass-Steagall law Obama essentially wants to resurrect primarily prohibited commercial banks that took deposits from engaging in risky trading. Although it was repealed by Congress in 1999 and heralded at the time as bringing deregulation to a backwards financial system, Obama says that by rebuilding the wall we'll be getting sensible bank regulation again.

That's great … except we won't. Bear Stearns, Lehman Brothers, Goldman Sachs (NYSE: GS  ) , and Merrill Lynch were stand-alone investment banks. They weren't taking depositors' money, so they wouldn't have been covered by the Act. Neither would American International Group (NYSE: AIG  ) fit under that umbrella, nor Fannie Mae (NYSE: FNM  ) and Freddie Mac (NYSE: FRE  ) .

And the commercial banks that ultimately did implode -- Wachovia, Countrywide Financial, and Washington Mutual -- didn't have any significant investment banking business. Their sin was in taking on too much mortgage risk -- risk they were implicitly (if not explicitly) encouraged to shoulder by the politicians in Washington now trying to curry voter favor by excoriating them.

But it woulda helped, right?
Wrong! The signature events that were heralded as staving off the complete collapse of the financial system were also the ones that wouldn't have been possible had Obama's new proposed regulations been in place. JPMorgan Chase (NYSE: JPM  ) couldn't have bought Bear Stearns and Bank of America (NYSE: BAC  ) couldn't have had Merrill Lynch foisted on it.

OK, maybe Ken Lewis and B of A shareholders are wishing something concrete was in place that would have stopped them from getting steamrolled with Merrill, but the argument behind the maneuver was that Merrill was too big to be allowed to fail.

Repealing the law -- a partial repeal, actually -- helped bring innovation to the financial services industry, and no, that didn't include securitization, which many have pointed a finger at as helping to undermine the system. Securitization was actually created back in the 1970s when Glass-Steagall was in full force and banks were giving us toasters for our deposits, and it'll remain available to banks even if Obama is successful.

What Goldman wants, Goldman gets
Goldman Sachs is a bank in name only; I haven't seen too many retail branches popping up on the street corner. So if it wants to avoid the restrictions Obama is placing on it, then it only need give up its bank holding charter and it will be allowed to trade its own accounts or invest in hedge funds -- and inject risk right back into the system! Same goes for some of those other "banks" that were allowed to convert to qualify for taxpayer handouts, like American Express and Morgan Stanley (NYSE: MS  ) .

They got it all backwards
In short, the real problem rests not with banks and investments, but with the notion of "too big to fail." It was the banks that didn't have more options open to them -- the investment banks that didn't have commercial banking divisions to provide stability -- that got the worst of it and brought "banking" to its knees. President Obama's plan doesn't change that, and in fact, would enshrine it. Resurrecting Glass-Steagall solves nothing, corrects nothing, prevents nothing.

Our financial institutions don't need to be further handicapped, placing them at a competitive disadvantage in international markets. A sound framework may be called for, but that doesn't mean a new "Glass ceiling" needs to be erected over them.

See what fellow Fools Morgan Housel and Anand Chokkavelu think about President Obama's proposed banking regulation here and here.

American Express used to be a Motley Fool Inside Value recommendation. 

Fool contributor Rich Duprey does not have a financial position in any of the stocks mentioned in this article. You can see his holdings. The Motley Fool has a disclosure policy.

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