Tuesday, 15 September 2009

Lehman Brothers and Glass Steagal - solving the problem of banking regulation

Today is the first anniversary of the filing for Chapter 11 Bankruptcy Protection of Lehman Brothers Holdings Inc. due to liabilities incurred from the trading of derivatives. Lehman was subsequently sold on to Barclays Capital, which arguably picked up a great bargain cheaply, while the rest of the investment banking industry, including competitors Merril Lynch and JP Morgan, found itself a similarly difficult situation. The US government found itself forced to bail out many of the remaining banks, while in other countries, including the UK, the banking system found itself at similar risk of implosion leading to similar state aid and a chain of amalgamations.

Lehman was among the largest of the US Investment Banks. While Lehman has a history stretching back to 1850, and before as a merchant house, Investment Banking as a distinct type of banking in the US had emerged following the Glass-Steagal Act, or Banking Act of 1933. This act was passed in the aftermath of the 1929 crash, when it was believed that banks had lent too rashly against securities during the Wall Street boom of the late 1920s. Glass-Steagal forced banks to delineate themselves as either commercial banks, which would carry out day to day banking activity, or investment banks which would specialize in security trading and other investment activities. Commercial banks were restricted to sourcing only 10% of their income from securities, though they could underwrite government bonds. Deposits in commercial banks were also now insured by government. Investment banks meanwhile were permitted to carry on underwriting and investing in securities. While Glass-Steagal was repealed by congress in 1999 it had the effect of dividing the US banking market into strict commercial and investment spheres until the crisis of Autumn 2008 as banks had by this stage built up specific competitive advantages in their home areas.

When last year's crisis hit some investment banks transferred themselves back to the commercial sector to gain state aid. The structure of the US banking industry for the previous seventy years had changed instantly due to a crisis, essentially the same reason as the structure had been adopted. Despite the claims that policymakers have done little to regulate the activities of bankers this time round, is it perhaps just possible that they are doing the right thing by letting the dust settle before taking any action?

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About Me

London, United Kingdom
I'm Lecturer in Management at The York Management School, at The University of York, UK. I teach strategic management to undergraduate and masters students, as well as running the masters dissertation module. My research focuses on business and management history.