That Choking Sound In DC? That's Sen. Glass

Register now

Sen. Carter Glass must be rolling over in his grave. The diminutive senator from Virginia was one of the foremost critics of the Wall Street machinations that some blamed for the stock market crash of 1929. His work helped forge post-Depression legislation that separated investment banking from commercial banking. The Glass-Steagall Act was just one of many new laws that came out of the debacle following America's greatest financial crisis, which also gave birth to the Securities and Exchange Commission.

The thinking by Sen. Glass and others was that the mixing of the two activities created an inherent conflict of interest, under which the sales forces for those Wall Street firms underwriting stock issues were encouraged to tout their firm's issues, often at the expense of the investing public. Hearings on Capitol Hill highlighted the conflicts of many firms that engaged in both types of activities.

But the emergence of the diversified financial conglomerate has ushered in a new era, where firms provide all forms of services for individuals and institutional clients en masse.

It took decades to accomplish, but the financial industry lobby finally succeeded in eliminating the last vestiges of Glass-Steagall via the so-called Gramm-Leach-Bliley Act, which once again allowed firms to officially mix investment banking with commercial banking and a host of other financial activities. Of course, many had been doing so for years anyway under administrative fiat, undermining the act.

One of the promises that convinced Congress to repeal Glass-Steagall was the existence of a "Chinese Wall," an invisible barrier, policed only by the goodwill of the Wall Street firms, that would separate such activities as investment banking from securities sales to individuals. But important e-mails uncovered recently in New York illustrate that it was common practice for firms (Merrill Lynch, is the one being singled out now), to have their "independent" analysts tout stocks that were being underwritten by the investment banking side of the firm, even when they knew the stocks to be real dogs. This is just the sort of conflict that the Chinese Wall was supposed to protect investors against. At least that's what the banking lobby promised Congress in order to convince them to repeal Glass-Steagall.

Those in the credit union movement ought to be following this scandal closely as they contemplate exercising the new powers granted them to move securities and insurance activities in-house under NCUA's incidental powers Rule. While credit unions themselves may not be underwriting securities, there are other potential conflicts. For example, will credit union sales representatives be encouraged to favor one mutual fund or insurance product over another because the credit union is being paid a commission? Will sales reps churn sales of sub-prime products just to boost revenue volumes?

Credit union people always say they're different, that they're not motivated by profit, but by member service. But human nature is human nature. These are some of the difficult issues that have been brought to light by the growing scandal on Wall Street.

For reprint and licensing requests for this article, click here.