Here's Proof a New Glass-Steagall Act Could Rein in the Big Banks

The Too-Big-to-Fail banks have a notorious track record of avoiding, evading or eliminating nearly all of Washington's attempts to bring them to heel.

So skeptics can be forgiven for thinking that the recently proposed new Glass-Steagall Act won't change anything on Wall Street.

As the moniker "Too-Big-to Fail" implies, such banks are not easy to push around.

"No bank will ever get out of a profitable line of business, unless they're forced to, or there's a huge loss that threatens the perception of the banks' risk management, or some scandal forces a mea culpa and an exit," said Money Morning Capital Wave Strategist Shah Gilani, who as a former hedge fund trader understands how Wall Street thinks.

Yet the Too-Big-to-Fail banks have recently pulled back in one area – physical commodities trading – as a result of regulatory pressure from several directions.

That's good news for proponents of the 21st Century Glass-Steagall Act, introduced on July 11 by Sens. Elizabeth Warren, D-MA, John McCain, R-AZ, Maria Cantwell, D-WA, and Angus King, I-ME.

But the story of the Big Banks reversing course on the physical commodities trading also proves that it takes a lot of effort, and sustained effort at that, to curb such risky behavior.

Why Physical Commodities Trading at the Banks is Allowed

Banks only started to trade physical commodities – oil, metals, agriculture – following the 1999 Gramm-Leach-Bliley Act, which repealed key provisions of the original Glass-Steagall Act of 1933, and a 2003 letter from the U.S. Federal Reserve that allowed Citigroup to keep its just-acquired Phibro unit, which traded in the physical energy markets.

The original Glass-Steagall and Federal Reserve rules had prohibited banks from engaging in "non-financial activities" such as physical commodities trading.

When Citigroup got the green light on Phibro, it opened the door for banks not just to trade commodities on paper as they had done for years (via derivatives), but to own the underlying physical commodities and to own the infrastructure used in storing and transporting those commodities.

"Congress, regulators, and the public need to understand what has happened in the 14 years since the financial floodgates were opened, and reconsider what we want banks to do," said Sen. Sherrod Brown, D-OH.