What Is the Glass-Steagall Act, and Why Is It Important?
The Glass-Steagall Act (GSA) was passed in 1933, following the stock market crash of 1929 and during a nationwide commercial bank failure and the Great Depression. It was introduced by two members of Congress and became known as the Glass-Steagall Act (GSA). It was intended to separate investment banking from commercial banking activities.
At the time, improper banking activity–that is, the overzealous involvement of commercial banks in stock market investment–was widely believed to be the primary cause of the financial catastrophe. It was believed that commercial banks were taking on too much risk with the money they received from depositors.
Throughout the years, further reasons for the cause of the Great Depression emerged, prompting many to wonder whether or not the Glass-Steagall Act prevented the development of financial services organizations that might compete on an equal footing with one another.
The Most Important Takeaways
- When the Glass-Steagall Act was created in 1933, it was in response to commercial banks’ involvement in stock market investment that the separation of investment and commercial banking activities was established.
- This blending of commercial and investment banking was deemed to be excessively dangerous and speculative, and it was widely believed to be a contributing factor to the Great Depression in the United States.
- The mandate to choose between commercial banking and investment banking was granted to banks; however, an exception was made to allow commercial banks to underwrite government-issued bonds.
- As a result of the repeal of the Glass-Steagall Act’s prohibitions on affiliations between commercial and investment banks in 1999, some have argued that this was a contributing factor to the financial crisis that occurred in 2008.
Recognizing the significance of the Glass-Steagall Act
Pre-Depression commercial banks were accused of being overly speculative because they were moving capital away from their core businesses and into speculative enterprises. As a result, banks got overconfident, assuming enormous risks in the aim of reaping even greater gains. Banking itself had become sloppy, and the aims had become muddled as a result. Unsound loans were made to companies in which the bank had a stake, and clients were urged to make similar investments in those companies’ equities as a result.
Sen. Carter Glass, a former Treasury Secretary and the co-founder of the United States Federal Reserve System, was, along with Henry Bascom Steagall, one of the key forces behind the passage of the Glass-Steagall Act, which established the Federal Reserve System.
Mr. Steagall served in the U.S. House of Representatives, where he was the chairman of the House Banking and Currency Committee. In exchange for the addition of an amendment allowing for bank deposit insurance, which was responsible for the establishment of the Federal Deposit Insurance Corporation, Steagall and Glass agreed to support the legislation (FDIC).
The Glass-Steagall Act, passed in reaction to one of the biggest financial crises of the period, established a regulatory barrier between commercial and investment banking activity. Banks were given a year to decide whether they wanted to specialize in commercial or investment banking services. Commercial banks were only authorized to earn ten percent of their overall income from securities; however, an exception enabled commercial banks to underwrite government-issued bonds.
With the passage of the statute, the Federal Reserve was allowed to supervise retail banks3, establish the Federal Open Market Committee, and, ultimately, more effectively administer monetary policy.
Financial behemoths of the time, such as JP Morgan and Company, who were perceived to be contributing to the problem, were directly targeted and compelled to reduce their services, so reducing one of their primary sources of income and causing them to go bankrupt. The Glass-Steagall Act sought to prevent banks from using deposits in the event of a failed underwriting job by putting in place this barrier. 5
Also enacted was the Glass-Steagall Act, which was intended to encourage banks to use their funds for lending rather than for investing in the stock market. This was done with the intention of increasing business. The act’s provisions, on the other hand, were seen negatively by many in the financial industry, and it was very contentious.
According to the New Deal, the Act was signed into law by President Franklin D. Roosevelt on June 16, 1933, and became effective immediately.
In 1945, it was made a permanent policy decision.
Additional Regulations for the Banking Sector are being considered.
The Glass-Steagall Act was passed in 1933, but the Federal Reserve Board, the nation’s bank regulator, did not fully execute it until 1956. As a result, Congress took steps to further regulate the banking sector in 1956.
With the goal of preventing financial conglomerates from accumulating an excessive amount of influence, the Bank Holding Company Act concentrated on banks that were active in the insurance industry. The United States Congress decided that taking on the substantial risks associated with insurance underwriting is not sound banking practice.
This resulted in a greater separation of financial activity by erecting a wall between insurance and banking, which was seen as a continuation of the Glass-Steagall Act. Despite the fact that banks were permitted to offer insurance and insurance products under this legislation, they were not permitted to underwrite insurance under this legislation.
The Gramm-Leach-Bliley Act and the 1999 Repeal and Replace Act
The Glass-Steagall Act, which imposed restrictions on the banking sector, ignited a discussion about how much regulation is too much for the business to withstand. There has been much discussion over whether allowing banks to diversify their businesses has the ability to minimize risk in the banking industry.
There was a strong argument made by these critics that the Glass-Steagall Act’s limits may potentially have a negative effect, making the banking system riskier rather than safer as a result. Furthermore, the transparency measures used by large financial institutions reduce the likelihood that they will take on excessive risk or that they will be able to conceal poor investment decisions.
When the Glass-Steagall Act was repealed by Congress in November 1999, it was met with widespread acclaim in the banking industry.
The Gramm-Leach-Bliley Act, also known as the Financial Services Modernization Act, was passed in response to the repeal of the Glass-Steagall Act, which prohibited ties between commercial and investment banks.
The Global Financial Crisis of 2008
Following the passage of the Gramm-Leach-Bliley Act, commercial banks resumed the practice of making high-risk investments in order to increase their earnings and return to profitability. According to many economists, this surge in speculative and risky activity, which included the rise in subprime lending, was a contributing factor to the 2008 financial crisis.
Despite the fact that the Glass-Steagall Act has a reputation for being scapegoated, proponents of repeal argue that it was only a minor contributor to the most recent financial crisis at the most. Instead, they assert that almost $5 trillion in essentially worthless home loans, among other issues, was at the heart of the 2008 financial catastrophe. Despite the fact that the repeal allowed for far larger banks, it cannot be held responsible for the financial catastrophe. 10
Glass-Steagall Act Frequently Asked Questions
Isn’t it clear what the Glass-Steagall Act was supposed to accomplish?
The Glass-Steagall Act was enacted in order to distinguish between investment banking and commercial banking activity. As a result of the 1929 stock market crash, the organization was founded.
What Was the Reason for the Repeal of the Glass-Steagall Act?
Because of long-standing concerns that the restrictions put on the banking sector were unhealthy, the Glass-Steagall Act was abolished in 1999, resulting in the realization that allowing banks to diversify would actually lower risk.
Is the Glass-Steagall Act still in effect? Yes, the act is still in effect.
No. It was repealed in 1999, during the administration of President Bill Clinton.
What’s the bottom line?
There was widespread agreement that the stock market crash of 1932 and the subsequent downturn were the result of banks being overly aggressive with their investing decisions. The premise was that commercial banks were taking on too much risk with their own money, as well as the money of their customers.
When the GSA took effect, it made it more difficult for commercial banks, which were in the business of lending money, to engage in speculative investment. It was stipulated that banks could only earn 10 percent of their revenue through investments (except government bonds). The purpose was to impose restrictions on these financial institutions in order to avert another financial crisis. The regulation was met with a great deal of opposition, yet it remained in place until it was repealed in 1999.