The solution to the problem of “too-big-to-fail” could be as simple as making big banks smaller, says former Federal Reserve Chairman Paul Volcker.  Along with Bank of England Governor Mervyn King, Mr. Volcker has called for the dissolution of mega banks such as Bank of America and Citibank, to allow the separation of risky investment activity from that of traditional retail banking.

Governor of the Bank of England
Governor of the Bank of England

Old Fashioned Banking

Mr. Volcker’s suggestions, which have been raised before hearings in Congress and to the Obama administration, suggest that recent problems in the banking world come from the fact that traditional retail banking activities such as checking, savings and loans, are no longer separated from the world of investment banking, due to the existence of large banking corporations that have their fingers in both pots. Volcker suggests a revisiting or strengthening of the Glas-Steagall Act of 1933, which, in response to the Great Depression, separated banks according to the type of banking they were involved in, such as commercial or investment.

One Way or Another

So far the US government has sided with the large banks on the issue, claiming that there is unacceptable risk in dissolving these large institutions. However, as Bank of England Governor Mervyn King stated in a recent speech, there are two ways to try and prevent a financial meltdown like the one that occurred last year. One way is to claim these banks are too big to fail, and do whatever it takes to make sure that they don’t, and another is to create a banking system where insolvent, unprofitable institutions can be allowed to fail without posing a huge risk to society.

Mr. Volcker believes that it is especially unacceptable that banks continue to take these gambles with taxpayer money, in the form of government bailouts. However, since that money is already spent, investing it in high risk areas may be the best way to get bailed-out banks the revenue needed to actually eventually pay back some of those taxpayer dollars.

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