I started this out as a comment to Sean Paul's recent opinion that we should reinstate the Glass-Steagall Act, which kept lending banks separate from investment banks. Doing so would deny investment banks access to cheap credit and FDIC insurance, which would mean they wouldn't be able to over-leverage themselves like they did over the last few years.

It sounds good to me... but frankly I'm not smart enough to know if its a good idea... and I do have one nagging concern... We need to make certain we keep our banking system not only stable, but profitable. Because if we don't, we might cripple part of our economy.

More after the jump.

Back when George Washington was president, Alexander Hamilton set up a financial system for our country. It had scary concepts like federal reserves, central banks, government bonds, etc. There were some financial bubbles and crises during this time... essentially because normal people went nuts and traded stocks instead of doing "real work."

However... Hamilton knew that in order for the US to be a strong country, we needed these things. We needed strong central banks who -- quite frankly -- didn't concern themselves over whether or not people were starving. That's the responsibility of the politicians; not the bankers. It sounded cruel, but that was the only way to create a country strong enough to avoid the tyranny of European powers.

Jefferson HATED Hamilton and his New York money men... and criticized Hamilton relentlessly for his greed. However, when Jefferson became president, did he dismantle the system? No... because it was necessary.

Fast forward to today... if we repeal Glass-Stegal -- but Dutch and English banks do not -- won't that cause capital flight? Won't people get a safe, high interest rate with foreign banks? Won't internet banking just cause people to chase the best deals, regardless of regulations?

UPDATE: And what about Chinese banks? It's usually not a good deal to put cash in savings accounts in European banks, mainly because exchange rates are too hard to predict, and your gains might be wiped out... but China pegs its currency to the dollar at an "official" rate. An insured savings account in China could make HUGE returns.

Yes, blending banks together means that they can take HUGE risks and still get government bailouts. So this is clearly a problem... but only if the banks are "too big to fail." Maybe instead what we need is a "cap" on how much the government will pay out for FDIC insured accounts? The government could make it clear that if you have money in a bank that is "too big to fail," your cash will no longer be FDIC insured.

Likewise... we need very firm regulations about inter-bank investment schemes that threaten the entire system. Things like credit default swaps should go the way of the dodo... but things like collateralized debt obligations might actually be OK.

I'd be perfectly happy keeping $50k in a savings account is an investment bank: it means that I'll probably get a higher interest rate. I'd get an even higher rate in a non-insured money market fund. If my bank fails, I won't see my money market again... but as long as my bank has assets under a certain amount -- say, $1 billion -- my savings account will be safe.

I think the cat is out of the bag, and Glass-Stegal will remain repealed... so we probably need to look towards regulations in other ways that allows banks to safely fail.