JPMorgan Mess: Bust Up the Big Banks

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK (TheStreet) -- JPMorgan's (JPM) $2 billion loss from betting on corporate bonds will embolden advocates of the Volcker Rule -- a provision of the 2010 Dodd-Frank law that will prohibit banks from trading on their own account. Unfortunately for federal regulators, trading in securities is essential to modern banking, and busting up the big Wall Street financial houses may be the only way to better ensure financial stability.

The Glass Steagall Act of 1933 separated commercial banking -- taking deposits and making loans to finance businesses, homes and the like -- from investment banking -- selling stocks, bonds and other securities, and making markets for investors to buy and sell those assets quickly. That separation was repealed during the final years of the Clinton Administration, and Wall Street institutions like JPMorgan now perform both roles.

Modern commercial banking simply won't tolerate such an absolute separation, because banks cannot finance all the demand for loans from deposits. In recent decades, too many savers have found they can earn higher returns than at the bank by investing in money market funds, bond funds and directly buying bonds.

Consequently, banks make loans, issue credit cards and the like, and bundle borrowers' promises to pay into securities and sell those to bond investors. Fannie Mae and other government backed housing banks don't take deposits at all, and get virtually all their financing selling mortgage-backed securities.

Also, regional banks can buy securities backed by the loans of banks in other regions to mitigate the risks inherent in serving a local economy. Kansas banks are just too dependent on the price of corn, and do well to hold some debt whose repayment depends on the vitality of other regions and industries.