(FORTUNE Magazine) – BANKERS are readying an assault on one of Wall Street's most cherished domains: securities underwriting. The betting in Washington is that, before the year is out, the Federal Reserve Board will permit banking companies to expand into several underwriting businesses. Among the possibilities are commercial paper, municipal revenue bonds, and securities backed by mortgages and consumer loans, which together represent three-fourths of the $540 billion a year in financing now off limits to these institutions. The Fed will be blasting the biggest hole yet in the 53-year-old Glass-Steagall Act separating U.S. commercial and investment banking. That is good news for borrowers, for the added competition should drive down the cost of financing. The banks, which have stood by while investment houses made off with more and more of the nation's financing business, can hardly wait to move into the new territory. Bankers Trust is all set to unveil an underwriting subsidiary, and a special securities unit of the J.P. Morgan bank holding company -- so far confined to government bond trading and limited municipal bond underwriting -- is ready to expand. Dennis Weatherstone, chairman of Morgan's executive committee and a captain of its push into investment banking, hopes the Fed move will be a mere prelude. Why not let banks handle all underwriting, including stocks and corporate bonds? Says Weatherstone, a crispspoken Briton: ''We are quite confident that if we could underwrite and deal in corporate bonds, there would be real improvements in the market, to the benefit of issuers.'' Such talk means war to the Securities Industries Association, lobbying arm of the investment banking industry. Still smarting from an unsuccessful court battle to keep commercial banks out of discount brokerage two years ago, the investment banks are trying -- vainly, it appears -- to dissuade regulators from allowing another invasion. Warns the SIA: ''The banking system is currently too fragile to permit banks to enter new businesses, especially those as risky as the securities business.'' Underwriting has special perils, Wall Street money men assert. Between the time an underwriter hands the borrower his money and markets the debt, they say, it is exposed to abrupt shifts in the bond markets that can stick it with large losses. When bond prices collapsed in 1979, in fact, an underwriting syndicate took a famous $10-million beating on a $1-billion IBM bond issue. The bankers retort that such losses are atypical -- and small compared with those they face in some of their regular business, lending to troubled farmers, energy companies, and Third World countries. They make good money underwriting securities abroad, where they are up against no Glass-Steagall wall. And they contend that in today's world, where money moves electronically among assorted financial institutions and across frontiers, the law is an anachronism. A look at the underwriting businesses that may open up suggests how banks and borrowers stand to gain: COMMERCIAL PAPER. Corporate lending, once the bedrock of the banking business, has eroded as companies have found it cheaper to issue short-term IOUs called commercial paper. Investment banks underwrite and sell the paper. The business has grown from $13.6 billion of paper issued in 1963 to an estimated $320 billion this year. As a result, banks have found themselves lending increasingly to companies whose inferior credit ratings bar them from selling the IOUs. This worries regulators concerned about the long-term health of banks. The most outspoken is Comptroller of the Currency Robert L. Clarke, who says, ''The banks need an opportunity to recapture some markets they have been forced out of, or they are going to become much weaker.'' Goldman Sachs and Merrill Lynch, which are believed to control two-thirds of the commercial paper business, will be no pushovers if the banks are allowed to compete. But Perrin Long, an analyst at Lipper Analytical Securities who covers the securities industry, thinks the banks ''could be damn successful. There are longstanding ties between banks and corporations.'' The banks view commercial paper primarily as a way of preserving those ties rather than as a profit maker. Spreads are already thin in commercial paper -- typically one-eighth of 1%. MUNICIPAL REVENUE BONDS. Glass-Steagall explicitly allows banks to underwrite and trade general obligation bonds, which are backed by the taxing power of state and local governments. But as regulators have interpreted the law until now, the underwriting of municipal revenue bonds, which hardly existed when Glass-Steagall was enacted, has been largely taboo. Asked what has kept the commercial banks out, William M. Isaac, former chairman of the Federal Deposit Insurance Corporation, snaps, ''Special interest politics. The investment banking community has had this thing tied up.'' Bond issuers would welcome the banks' full participation in this business, which accounted for two-thirds of the $220 million in new muni bonds issued last year. The American Public Power Association, representing electric utilities owned by states and municipalities, recently told the Fed, ''Increased competition in underwriting revenue bonds will lower the cost of financing for public power sytems, and thus lower costs to consumers.'' SECURITIES BACKED BY MORTGAGES AND CONSUMER LOANS. According to IDD Information Services, the underwriting of mortgage-backed securities has zoomed, to $30 billion so far in 1986. By peddling home mortgages they originate but do not want to hold, thrift institutions and banks raise money for more lending. A handful of Wall Street firms, notably Salomon Brothers and First Boston, dominate the business of packaging, underwriting, marketing, and trading mortgage-backed securities. ''We could capture a reasonable share of the market,'' says George Vojta, executive vice president of Bankers Trust. Far newer and smaller in volume is the packaging of securities backed by consumer debt, such as credit card balances. Bankers, who want in, expect this business to grow dramatically. Banks began petitioning the Fed a year and a half ago for a broader underwriting role. Parsing the muddy language of Glass-Steagall, they maintained that the underwriting they would perform is legal, so long as it is done by other subsidiaries of a bank holding company for which it is not the principal business. Any losses, they say, would not endanger the solvency of the bank itself. Fed Chairman Volcker held off action in the hope that Congress would move ahead with legislation to broaden the banks' powers. But the lawmakers stalled, and Volcker hinted in June that the Fed might act on its own. ''I think he is going to have to,'' says a high Administration official. Fed action would further weaken a law whose own coauthor long ago had second thoughts about it. Though the fact is forgotten, Senator Carter Glass of Virginia sponsored a bill authorizing banks to get back into underwriting corporate bonds just two years after Glass-Steagall was enacted in 1933. He hoped this would encourage banks to finance beleaguered businesses trying to climb out of the Depression. Asked if his bill would allow the Morgan bank to underwrite securities, Glass said, ''Well, why not?'' Glass's bill passed the Senate, but died in the face of opposition from President Roosevelt and others. Perhaps the best argument for turning the banks loose is the success they have had underwriting overseas. In the London-based Euromarket, where financial institutions raise money from all over the world, banks compete freely with securities firms. J.P. Morgan ranked third among all Eurobond issuers last year, behind Credit Suisse-First Boston and Merrill Lynch but ahead of Salomon Brothers, Morgan Stanley, and Goldman Sachs. Bankers Trust and Bank of America were also major underwriters. J.P. Morgan earned $15.9 million from its London securities operation in 1985, or a 26.2% return on equity; that compares with earnings of $10.2 million the year before. None of the banks' Eurobond subsidiaries has posted a big loss in recent years, much less threatened the solvency of its affiliated bank. If Glass-Steagall's strictures remain unchanged, bankers say, the U.S. financial community, with its millions of jobs, could lose business to foreign financial hubs where constraints are fast disappearing. Chemical Bank last year helped an Alabama customer, Kinder-Care Learning Centers, raise $50 million. The best deal for Kinder-Care was to sell medium-term bonds on the Swiss market, which Chemical did. But if Kinder-Care could have raised money more cheaply on the New York bond market, in Chemical's hometown, the bank would have had to bow out. With Japan liberalizing its financial markets and Britain's Big Bang creating new freedom to compete there, the U.S. can ill afford the rigidities of Glass-Steagall. Money is nothing if not an international commodity, and the business will go where the competition is freest.