Wednesday, May 30, 2012

How Political Clout Made Banks Too Big to Fail

by Luigi Zingales


May 30, 2012

The U.S. has historically kept the financial sector in check through a combination of sound principles and serendipitous decisions. But as the financial system gained strength in recent years, it also gained political influence. In the last decade, it has become too concentrated and too powerful, which has damaged not only the economy but the financial sector itself.

How did it happen? In 1933, the Glass-Steagall Act erected a wall between two ways that banks could help customers borrow money. The idea was to keep commercial banks from exploiting their depositors, who might get saddled with the bonds of firms that could not repay the money they owed. One beneficial side effect of the Glass-Steagall Act was to fragment the banking sector and reduce the financial industry’s political power. Another was to foster healthy competition between commercial banks and investment banks.


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