A historic debate is under way in Congress over reform of the Glass-Steagall Act, the 55-year-old law separating commercial banking and securities activities. As a result of revolutionary changes in financial markets over the past decade, banking firms want new securities powers. Securities firms by and large want to keep them out of their business. Lobbyists for these industries are engaged in a monumental struggle.

In extensive hearings on the merits of Glass-Steagall reform in congressional committees over the past several years, potential advantages from greater competition and improved efficiency in banking and securities markets have been weighed against potential risks to the banking system and to the deposit insurance funds. Legislation now under consideration in the House and Senate would allow firms to engage in both banking and securities activities, albeit within separately capitalized subsidiaries. The legislation, if passed, could reshape U.S. financial markets for decades to come.

In the immediate aftermath of the stock market crash, it was said that the crash solidified the case for Glass-Steagall barriers. But the opposite is true. The crash provided a powerful new argument for allowing commercial banking organizations to engage in securities activities.

The Report of the Presidential Task Force on Market Mechanisms (the Brady commission report) reveals a startling and disturbing aspect of the events of mid-October that bears on the Glass-Steagall debate. From the beginning of the market break on Oct. 14 to its culmination on Oct. 20, a handful of institutional investors, portfolio insurers and securities firms trading for their own accounts dominated the market. Here are the facts revealed in the report:

During the three trading days from Oct. 14 to 16, the Dow Jones Industrial Average declined more than 250 points. On Wednesday, Oct. 14, the 20 largest New York Stock Exchange firms sold a total of almost $700 million for their own accounts. On Thursday, seven ''aggressive trading institutions'' (the Brady commission's euphemism for the large investment banks that trade actively on their own behalf) sold more than $800 million of stocks, about 9 percent of NYSE volume, and on Friday four of them sold more than $600 million. To put these amounts in perspective, consider that on a normal day a trader buying or selling $10 million would be considered active.

On Monday, Oct. 19, the day the Dow fell more than 500 points, the record volume came from a small number of portfolio insurers, mutual funds and trading-oriented securities firms. Sales by a few mutual funds accounted for $900 million. One mutual fund group sold $500 million in the first half-hour of trading, representing 25 percent of total volume. For the day, it accounted for 90 percent of mutual fund sales. Altogether, the top four sellers on the NYSE accounted for $2.85 billion, or 14 percent of total sales. The top 10 sellers accounted for $3.2 billion, or more than 15 percent of total sales, while the top 10 buyers purchased $1.8 billion.

The Brady commission report concludes: ''Throughout the period {from Oct. 14 to Oct. 20}, trading volume and price volatility increased dramatically. This may suggest that a broad range of investors all decided to reduce their positions in equities. In reality, a limited number of investors played the dominant role during this tumultuous period.''

In sum, the report shows a securities market dominated by a handful of institutional investors and traders who based decisions largely on internal market dynamics. The Brady commission did not draw any policy conclusions regarding the concentration of selling activity. Instead, its policy recommendations focus narrowly on the operation of the markets for equities and their derivative instruments.

But one of the clearest policy implications of the crash is that Congress should repeal those sections of Glass-Steagall that prohibit bank holding companies from engaging in securities activities. The Glass-Steagall Act is a significant regulatory barrier to entry into securities activities that has quite probably contributed to industry concentration. It prohibits banks and their affiliates from sponsoring mutual funds (they can distribute funds managed by others), trading equities and providing full-service securities brokerage. Since commercial bankers have expertise in related financial activities and have customers who use these services, they would be logical new entrants into the highly concentrated securities and fund management markets.

The efficiency and the integrity of our capital markets depend on a large number of investors' basing their decisions on their independent judgment of the long-term prospects of U.S. securities. Reform of Glass-Steagall cannot guarantee that good judgments will be made, but it will, in time, diffuse decision-making and spread control of financial assets, as banking organizations expand their role in securities markets. Although this will not ensure against a repetition of ''The Crash of '87,'' greater diversity in financial management and control will help protect securities markets from the tactical decisions of a few large traders.

Glass-Steagall was enacted as part of a package of reforms intended to restore the integrity of the financial system in the depths of the Great Depression. Given today's highly concentrated securities markets, the integrity of our financial system can be improved through Glass-Steagall reform.

The writer is the J. E. Lundy scholar and director of the Financial Markets Project at the American Enterprise Institute.