Commercial banks are where you and I, Joe and Jane Private Citizen, deposit our paychecks. It's where we have our personal savings and checking accounts, and perhaps certificates of deposit. We're talking about the dollars that are protected by the FDIC, which was established in response to the runs on banks during the 1930s, where *some* banks had bad stocks but people didn't know which banks they were, so everyone wanted to get their money out before they couldn't. In short, it's the money that private citizens deposit and also pay to insure with their tax dollars. The FDIC was established by the Glass-Steagall Act (AKA the Banking Act of 1933), and one of the provsions of the Act was a separation of 'commercial' and 'investment' banking, to attempt to prevent losses from investing in securities from impacting the banks' ability to redeem deposits.

During the late '80s, banks were actively trying to remove the distinction between commercial and investment banking (investment banking being the other side of the coin, uninsured, potentially high-risk, complex financial transactions and market activities), because the securities markets were providing opportunities to diversify and improve profits, and since much of the rest of the world did not separate commercial and investment banking, they felt disadvantaged in the marketplace. Here was all this cash, and the risk profiles in the securities world were deemed to be equal or better than what they could build on the commercial side, so the law was seen to be archaic and limiting.

In 1999, President Clinton signed a compromise bill (introduced by Republicans in the Senate and House) which effectively repealed Glass-Steagall's separation provisions.

So the recent announcement is, in a sense, trying to turn back the clock a bit on some aspects of the separation of commercial and investment banking. Paul Volcker, in an interview with BusinessWeek, says, "The kind of reform I've been advocating is acceptance of the fact that the core of the system remains commercial banking." The rules are intended to protect the individual consumer accounts, and more importantly, the government funds used to insure them.

So what does this really mean? Why should anyone care? Well, mega-banks like Citigroup care a lot, because they have deeply embraced the freedoms provided by the repeal and reorganized themselves around a much looser separation of commercial and investment banking operations. To them, it's another expensive reorganization effort followed by restrictions on their capital base -- upon adoption, they would need to refinance any of the investments in capital markets that they hold to eliminate depository dollars. Imagine if you had a $300,000 house, which just lost value in the recent housing market downturn, and was now worth $250,000. Now, due to a law change, the mortgage company tells you that an additional $50,000 of that loan must be repaid (the part that is funded by consumer dollars), so you have to go to a mortgage broker and get a new $100,000 loan for one-and-a-half times the interest. Pure suckage.

On the flip side, the tax burden to support FDIC insurance for accounts goes down a bit; there is less risk that a bank could be 'too big' to fail -- the securities business could fail on its own, unwinding in an orderly fashion, without using FDIC funds to pay depository redemptions. If the core of the economy is truly commercial deposits, then this would certainly help to solidify confidence in the integrity of those deposits.

Unfortunately, I'm not exactly sure if this solves the problem that needs to be solved. It is in the best interest of market participants to have a wide array of tools to reduce risk at their disposal, and it's not an unreasonable argument that the market boom which we experienced leading up the to recent crisis was a result of the free flow of capital enabled by the repeal of Glass-Steagall. So restricting that freedom, when there are already market-based restrictions of capital due to the devaluation of mortgage-backed and credit derivatives, could lead to challenges for growth of new business and new markets. It also completely ignores the benefits of central clearing of credit derivatives, and how encouraging participation in centrally-cleared credit markets could help reduce the risk of a repeat of this recent credit crunch regardless of this kind of legislation; I think it would be prudent to address some of the root causes of the credit crunch rather than effectively sticking it to the banks who got TARP money. (Not that they deserve sympathy, really, but that we should be trying to avoid others repeating mistakes rather than continuing to punish the existing fuckups.)

But whenever politics and complexity collide, it's always important to put a public face on the complexity so people can absorb it. I just wish that the public face had a little lighter touch.