The Wall Street Journal

July 27, 2012, 6:39 p.m. ET

Sandy Weill was impressive as a scrambler, a dealmaker, a man who could catch a wave. He's come out of retirement now, a decade after creating the Citigroup oligopolist, to catch a new wave, declaring on CNBC that investment banking and commercial banking should be re-separated.

He explains that bank bailouts and too big to fail would no longer be necessary, without explaining how, since both bank bailouts and too big to fail predated the repeal of Glass-Steagall.

Mr. Weill finds himself suddenly welcome in the company of editorialists who, since the Libor scandal, have been renewing their clamor for bankers to be imprisoned, if not executed. He's become their new hero.

The inherent Stalinism of those who crave to put bankers in jail for things that aren't crimes is not unlike that of the original Stalinist—who understood that nothing of substance has to change if you've got enough scapegoats. Likewise, Mr. Weill's proposal to restore Glass-Steagall would also change nothing.

Even too big to fail is too small a phrase. Do not interpret the following conspiratorially: The total coalescence of the financial elite with the governing elite in our and other countries is a natural pattern. It may be corrupting. It may be counterproductive. But it's the natural outcome of the giant, almost inconceivable amounts of debt the U.S. and other governments ask the financial system to market and hold on their behalf.

If you owe the bank $1 million, the bank owns you. If you owe $1 billion, you own the bank. If you owe several trillion, you are the financial system. Libor is called a key underpinning of global finance. But that's far more true of IOUs issued by the U.S. government and its major counterparts. The global financial system is built on a mountain of government debt, and in turn banks and their governments are bedfellows of a highly incestuous order.

That's why, in every transcript and phone memorandum that has come to light, in talking about Libor, regulators and bankers talk to each other as if they were all just bankers talking amongst themselves.

That's why, when a high British official suggested that Barclays lowball its Libor submission during the financial crisis, Barclays didn't hesitate because, as one banker testified to the British Parliament, these were government instructions "at a time when governments were tangibly calling the shots."

It's ironic to think that some who championed the euro saw it as way to break free of rule by bankers. Europe's new monetary authority would be focused on a producing a stable currency; Europe's national governments would have no choice but to live within their means.

This experiment failed because the European Central Bank quickly adopted policies designed to induce banks not to distinguish between the debts of disciplined and undisciplined governments. That is, the euro was immediately corrupted by the need to help governments keep financing themselves.

Now the world is Europe. Under the current regime of financial repression, banks and states are even more annexes of each other. Notice Japan's central bank explicitly stating plans to erode the value of the government's debt in the hands of Japanese savers. Notice the European Central Bank again hinting at readiness to buy the debt of countries no longer able to find voluntary buyers in the market. In the U.S., how long before the Treasury issues a perpetual bond yielding zero percent for direct sale to the Fed?

The banker-government consortium re-exposed in the Libor scandal won't be unwound from the top, not when governments are more dependent than ever on a captive financial system to give their debt the illusion of viability. And yet there's still a possibility of unwinding it from the bottom, by giving large numbers of bankers an incentive to get out of the government-insured sector and go back to a world in which they live by their own profits and losses.

The solution begins with deposit-insurance reform. The FDIC would stop insuring deposits that are invested in anything other than U.S. Treasury paper. The FDIC would be charged solely with seizing these assets when a bank gets in trouble so the claims of insured depositors can be satisfied. There'd be no call to bail out other creditors or shareholders to minimize the cost to the deposit insurance fund.

Yes, the threat might be only semi-credible. But such a law could be got through Congress and risk-averse lenders would become less interested in holding uninsured credits against banks that are too big to manage and too opaque to be viable without a government backstop.

The J.P. Morgans, Citis and Banks of America would stampede to get smaller. Finance could return to its natural role, arbitraging between good assets and bad ones. Who knows, we may yet need that function again one day to get out of our debt mess.

A version of this article appeared July 28, 2012, on page A17 in the U.S. edition of The Wall Street Journal, with the headline: Sandy Weill Still Doesn't Have the Answer.

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