Centre for Economic Policy Research

Conflicts of Interest in Universal Banking 63

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expense of the bank and its shareholders. The most common avenues for this 
activity were pool operations to support stock prices. During the boom period, it
was common for security affiliates to conduct pool operations in the stock of 
parent banks. National City Company maintained an active trading position in
the stock of National City Bank, as did many other affiliates for their parent 
banks.
59
The head of Chase, Albert H Wiggin formed six corporations for his 
family and other officers and directors of Chase National Bank and Chase
Securities Corporation. They also used these corporations to allow them to partic-
ipate in issues handled by the bank and its affiliates.
60
Perhaps the most shocking
example occurred during October-November 1929. Wiggin sold Chase’s stock
short at the time Chase was a member of a banking group trying to support and
stabilize the market (Carosso, 1970).
Congressional investigators were equally critical of Charles E Mitchell, the 
president of National City Bank and its affiliate, singling him out for failing to
safeguard the interest of shareholders and investors while giving management
bonuses and special investment opportunities. They objected to the management
fund set-up using the annual earnings of the bank and its affiliates. The manage-
ment fund guaranteed owners and managers a minimum return in the form of 8%
dividends and fixed salaries. The remaining profits were distributed to owners and
executives in a four to one ratio, ensuring executives received compensation as if
they had been important shareholders.
61
While this appeared dubious to contem-
poraries, it looked much more like an appropriate attempt to align incentives
properly so that top management would not attempt to favour one part of the
bank in favour of the other, rewarding them for its overall performance (See
Benston, 1990).
For these alleged problems, contemporary experts, like Peach (1941), offered
narrowly targeted remedies. Peach believed that the Securities Act of 1933 and the
Securities and Exchange Act of 1934 provided ample protections to investors by
ensuring adequate divulgence of information for new issues. To block private
profiting from pool operations, he recommended that it be made illegal for offi-
cers to participate individually in any business conducted by affiliates. Although
somewhat critical of management funds, he felt that they should be better publi-
cized. For the shifts of funding from loans to securities, he eschewed separation
and promoted what would be considered today as prudential supervision. He felt
that compulsory periodic examinations of security affiliates by federal authorities
in conjunction with the parent banks would prevent the shifting of undesirable
assets, pointing out that while one could not easily prevent banks from making
bad loans, one could prevent them from being hidden by shifting them around. 
The securities affiliates of commercial banks would have survived the New
Deal’s legislation in some regulated form, if the chairman of the Senate
Committee on Banking and Currency, the influential Senator Carter Glass, had
not insisted on a complete divorce of commercial and investment banking. Based
on his firm belief in the fallacious real bills doctrine, Glass refused to permit bank-
ing reform to proceed, even though he was the only important advocate of this
remedy.
62
Although Glass focused on the threat securities affiliates posed for the
safety and soundness of their parent banks, White (1986) showed that securities
affiliates did not weaken their parent banks. In fact, the presence of a securities
affiliate reduced the probability of a bank’s failure and had no deleterious effects
on solvency or liquidity.
63
Nevertheless, in the depths of the depression, the
Congressional hearings cast a pall over the affiliates, generating a myth that they
destabilized banks. Ironically, although Senator Glass’s concern centred on the
effect of banks’ soundness, belief in the importance of the 1920s conflicts of inter-
est grew over time. 
64 Conflicts of Interest in the Financial Services Industry

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The remedy Congress chose, complete separation, was seen as eliminating both
conflicts of interest and threats to safety and soundness. The Banking Act of 1933
revoked the securities powers of all Federal Reserve member banks. Sections 16,
20, 21 and 32 of the Banking Act became known as the Glass-Steagall Act. Section
16 limited national banks’ powers to the purchase of securities on their own
account and restricted them to dealing in some government securities. Section 20
ordered that after 16 June 1934 no member bank could be affiliated with any cor-
poration, association or business trust engaged principally in the issue, floatation, 
underwriting, public sale, or distribution at wholesale or retail through syndicate