There are basically two ways to make or evaluate government policy--superstition and logic. In the case of superstition, evidence is not necessary. Those who favor a particular policy don’t feel they have to defend it. It’s simply self-evident. The alternative--the use of logic--requires that there be rational explanation for a policy.

In this context, I’d like to consider the continued viability of the policy of separating banking and commerce after the adoption of the Gramm-Leach-Bliley Act in 1999. Is the policy still based on any comprehensible rationale or is it now simply a kind of superstition?

Those who are its supporters will of course argue that it is based on logic. They argue that the separation principle rests on some theory of economic harm--some way in which banks affiliating with commercial firms is likely to cause harm to one of the affiliating parties or to the economy at large.

Since we do not have a general principle against the affiliation of various kinds of commercial firms--conglomerate mergers and acquisitions may not always be sensible, but they are not illegal--the separation principle must posit that there is some kind of specific harm that will come from permitting banks, in particular, to combine with commercial firms.

This harm has in fact been catalogued repeatedly for Congress by advisers and commentators as eminent as Paul Volcker and Henry Kaufman.

In testimony to Congressional committees in recent years, Mr. Volcker identified three separate dangers of permitting banks to affiliate with commercial firms:

• The bank with a commercial affiliate will lend preferentially to the affiliate, whether willingly or under duress from a commercial parent.
• The bank with a commercial affiliate will not lend to competitors of its commercial affiliate.
• If the bank’s commercial affiliates get into financial difficulty, the bank’s resources will be marshaled to bail them out, whatever the law says.

It is not my purpose here to assess the validity of these arguments, even though I believe they are completely fallacious. The idea, for example, that a bank management would open itself to the enormous personal penalties that attend the violation of Sections 23A or 23B--merely to assist an affiliate in financial trouble--is to me preposterous. The success of the laws and regulations governing the management of investment companies is a sufficient demonstration that, for the most part, rules against overreaching an affiliate are obeyed.

But it is really not necessary to mount an attack on the separation of banking and commerce. The Gramm-Leach-Bliley Act does that for me. It eliminates whatever rational basis there might be for continuing to maintain the separation between banking and commerce. The only question now is how long it will take before Congress realizes the implications of what it has done--the way, in the roadrunner cartoons, the only question is how long it takes before the Wile E. Coyote realizes he is ten feet off the edge of the cliff and suspended in thin air.

The Gramm-Leach-Bliley Act has this effect because it undermines every rationale that has been advanced for separating banking and commerce. Accordingly, if all the logical foundations have been eliminated, the continued support of the principle of separation can only rest on superstition. That’s where I think it is today, and I expect that Congress--currently suspended like Wile E. Coyote--will eventually realize this.

If we go back to Paul Volcker’s three horribles, they all describe the evils that will occur when the suppliers of credit--i.e., banks--control or are controlled by the users of credit--i.e., everyone else.

I will assume for purposes of this discussion that Mr. Volcker is correct--that the principle of separating banking and commerce should be upheld because certain economic harms will occur when the suppliers of credit are permitted to affiliate with the users.

If we turn to the GLB Act, we find that Congress paid no attention to these supposed economic harms. The attempts to preserve some semblance of the separation principle drawing the circle around banks somewhat wider than before. Before the Act banks could only affiliate with firms that were engaged in activities that were "closely related to banking."

Now, after adoption of the Act, it is permissible for banks to be affiliated with securities firms and insurance companies--on the theory that all are involved in what is loosely called "financial activities" and not in what might be called "commerce." By passing the GLB Act, therefore, Congress has clearly accepted the idea that banks can be affiliated with securities firms and insurance companies.

Now, in what sense would it be true to say that this is consistent with the rationale for separating banking and commerce--which we understand to mean the separation of the suppliers from the users of credit?

Are securities firms users of credit? Certainly. In fact, they are among the most credit-dependent firms in the economy, since they carry their securities portfolios--their inventories--almost entirely with bank credit.

Are they users of credit in the same sense that, say, retailers like Wal-Mart are users of credit? Again, certainly.

Just to be sure we have this right, let’s test it against Paul Volcker’s three horribles. In doing this, I am assuming--as Mr. Volcker must have assumed--that there are no laws or regulations on bank conduct, or that they will be ignored.

Could a bank that is controlled by or under common control with a securities firm be required to lend preferentially to that firm? Of course.

Is the same thing true of a bank controlled by or under common control with a retailer--say, Wal-Mart? Yes.

Might a bank that is controlled by or under common control with a securities firm refuse to lend to competitors of that firm? Of course.

Is the same true of a bank controlled by or under common control with a retailer? Again, yes.
And finally, if the securities firm that controls or is under common control with a bank got into financial difficulties, could its affiliated bank, as Mr. Volcker suggests, be importuned to make funds available to bail it out? Of course.

And would the same thing be true in the case of the retailer. Again, yes.

So is there any difference--from the standpoint of the harms that the separation of banking and commerce is intended to prevent--between a bank affiliating with a securities firm and the same bank affiliating with a retailer like Wal-Mart?

It seems obvious that the answer is no.

If this is true, what is left of the rationale for separating banking and commerce? The answer has to be--nothing. If every abuse or potential abuse that is supposed to provide the underlying rational for the separation of banking and commerce could occur if banks are affiliated with securities firms--which Congress permitted in the GLB Act--what basis could there be for not permitting affiliations with retailers? Or for that matter with automobile manufacturers, oil companies or software developers?

The answer, it seems, is that there is no rational basis for the distinction; it is completely arbitrary.

Thus, by opening the door to affiliations between the suppliers of credit--banks--and the users of credit--securities firms--the GLB Act eviscerated the underlying rationale for the separation principle. Congress must no longer believe that affiliations between the suppliers or credit and the users of credit represent a danger to either, or to the economy generally.

Under these circumstances, the separation of banking and commerce must be on its way out. If it’s not supported by a comprehensible rationale, as I said at the outset, it’s nothing more that a superstition. And in a world where we go out fearlessly on Friday the 13th, walk under ladders, and ignore black cats, that’s not a very solid foundation for its survival.

Peter J. Wallison is a resident fellow at AEI.