THE BLOG

Glass-Steagall and Insider Trading

03/18/2010 05:12 am ET | Updated May 25, 2011

I wish to make clear upfront that this is purely hypothetical. If anything like this actually happened, I was not in the room, and nobody I know was in the room. Therefore, I ask you to consider it as purely a supposition:

Let us assume, hypothetically, that a major investment bank has acquired a major bank holding company (a company that has control over a bank and therefore is subject to Federal Reserve regulations). Let us assume that the bank holding company played a major role in the mortgage servicing industry. Let us also assume that the investment bank held among its assets many mortgage-backed securities. Let us assume that the Chairman in the investment bank/bank holding company held regular meetings at which both companies' department heads reported to him about their results:

Now, let us suppose that sometime in mid-2006, at one such meeting, the parent company Chairman asked his department heads if they knew of any developments that might affect the bank's financial performance. Suppose the head of the mortgage servicing division told the Chairman that homeowners were falling behind in the mortgage payments to his division. Assume that at that point the Chairman then called the company Treasurer and told him to "get us out of the mortgage-backed security business as quickly as you can." If the Treasurer did as he was told, the Chairman saved his company from the worst effects of the collapse of the sub-prime mortgage market. This would have been a very good thing for the company and for its shareholders. Moreover, since the repeal of the Glass-Steagall Act in 1999, it would've been entirely legal.

Glass-Steagall, which was one of the most important of the New Deal regulations passed in 1933, would have prevented the merger of the investment bank with the bank holding company. If the investment bank had learned about it from an outside source other than its own bank holding company, the use of it for its own profit, the Chairman and the Treasurer of the parent company would've gone to jail and their company would have been fined billions of dollars. But, since the information came from a division within the parent company, there were no legal problems. The investment bank that knew of the information would've flourished, while some of its rivals who had no access to such information would've crashed, as of course several did at the end of last year.

I'm sure that many Huffington Post readers have read about the dire effects of the repeal of Glass-Steagall, but I have yet to see any comments about the informational advantages it provides to financial institutions that sit on both sides of the fence. If I were running a financial institution now, I'd want to make sure that I owned a mortgage servicing company and a credit card servicing company, so that I'd have legal insider information and be able to shed assets when Americans were no longer meeting their credit obligations.

Of course, another solution would be the repeal of the repeal of Glass-Steagall, but I'm afraid that will be a long time coming.