It's Glass-Steagall, with a twist

The regulatory restructuring debate has included its fair share of nostalgia for the days when investment and commercial banking were strictly separated—the days before lawmakers took a sledgehammer to the Glass-Steagall Act. But a new wall going up between the two may diminish the need for wistful reflection. Investment and commercial banks are sinking into an image war, with the winner’s prize going to the side that ends up less reviled by the public and lawmakers.

In one corner, investment banking, with its bacchanalian bonuses and incomprehensible structured products, is taking a beating while in the other big commercial banks are being clobbered over the foreclosure crisis and new lows in mortgage lending practices come to light.

Bank of America is a good example: Its acquisition of Merrill Lynch and the bonus payouts that followed are stoking outrage from New York to Washington, while its record of performing loan modifications for customers was recently called out as one of the worst of its peer group. Wells Fargo is the subject of suits against its mortgage lending practices in Maryland and Illinois. And among the investment banks none is taking more heat than Goldman Sachs, with its colorful character attack in Rolling Stone followed by the New York Times’ revelations about its former Treasury Secretary Henry Paulson’s frequent phone time with Goldman CEO Lloyd Blankfein.

A natural separation seems to be reappearing between investment banks and commercial banks after a decade of attempts at integration. Goldman may have converted into a bank holding company, but the company’s heart still belongs to Wall Street. Bank of America, meanwhile, is finding itself outside looking in, with its takeover of Merrill creating more problems than it solved.

Though protests that free market forces have failed to properly govern the two worlds of banking may have merit, the future is likely to yield a Darwinian incarnation of Glass-Steagall. Investment and commercial banking could end up growing apart naturally, in a scenario in which life may indeed imitate regulation.