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Banking

Can the Fed revise the law? (separation of commercial and investment banking in the U.S.)

CAN THE FED REVISE THE LAW?

At the heart of the Bankers Trust case (page 13), lies the question whether the Federal Reserve's interpretation of Glass-Steagall, the law that separates commercial and investment banking in the US, is so unreasonable that it should be overturned by the courts. The Federal Reserve regulates banks in the US and oversees compliance with Glass-Steagall.

Glass-Steagall--the collective name for the four provisions in the 1933 Banking Act that imposed this rigid demarcation--was passed after the 1929 crash to prevent commerical banks from putting depositors' funds at risk by participating in speculative investment banking activities. Now that commercial paper has crossed that divide--as a security that has replaced short-term bank lending--the problem is what to do about Glass-Steagall, especially since commercial banks like Bankers Trust are selling commercial paper.

The Fed believes that the language of Glass-Steagall is wide enough to accommodate the activities of Bankers Trust. Last month, the Federal District Court in Washington disagreed. On Judge Joyce Green's interpretation, Glass-Steagall is a flat prohibition. If so, only Congress can lift it.

The Fed previously crossed swords with the court over the activities of Bankers Turst, when the Fed said in 1980 that commercial paper was not a security for Glass-Steagall purposes.

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