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systematically fooled and banks did not "abuse the public

trust" by issuing unexpectedly low-quality securities.

Thus, the historical record suggests that investors would

not be harmed by an end to Glass-Steagall and could benefit

from the convenience of one-stop shopping for financial ser-

vices.

Firewalls and Chinese Walls: What Type of Separations,

If Any, Should Be Mandated?

Firewalls have been proposed both to mitigate potential

conflicts of interest and to prevent the extension of the

government's bank safety net beyond depositor protection.7

Since the late 1980s, regulators have permitted bank holding

companies to operate so-called section 20 subsidiaries with

limited involvement in the securities markets.  Initially, a

maximum of 5 percent of the subsidiaries' revenues could be

from otherwise prohibited investment banking activities, a

revenue limit that has recently been increased to 25 per-

cent.  In addition, the subsidiaries face a variety of re-

strictions on the sharing of personnel and information with

the bank.  The exact structure of the separation has been an

important part of the current debate over financial modern-

ization legislation.

Again, the historical record can help to predict the

structures market forces would bring if Glass-Steagall re-

strictions were to end.  Prior to the Glass-Steagall Act,

banks entered the securities business in one of two ways:

through internal departments or separate affiliates.8  In-

ternal securities departments were organized within banks,

parallel with the banks' lending departments, much as clas-

sic German universal banks have organized themselves.  Af-

filiates were separately incorporated and capitalized firms

with their own boards of directors and their own balance

sheets, much like section 20 subsidiaries today.

During the 1920s, there was a strong trend toward the

adoption of separate affiliates and away from the use of

internal departments.  A key motivation for that movement

appears to have been concerns about internal departments'

reputation and credibility with investors.  Holding all oth-

er factors constant, investors rewarded separate affiliates

with higher prices for the securities they underwrote than

they did internal departments for otherwise similar securi-

ties.  Investors appear to have been concerned that the se-

curities underwritten through the internal departments were

riskier and so would not pay as high a price for them as for

otherwise similar securities underwritten through separate