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Updated on Friday, January 25, 2019
In 1933, as the United States was in the throes of the Great Depression, Virginia Sen. Carter Glass set to work on a bill to reform bank regulations. Co-sponsored by Alabama Rep. Henry B. Steagall, the aim of the bill was to separate commercial and investment banking, as many people at the time felt that their deposits were being used to fund risky and speculative investments, exacerbating the financial crisis the nation was facing.
Here are just a handful of the major changes brought forth by the Glass-Steagall Act, also known as the Banking Act of 1933:
- Limited the amount of interest that could be paid on savings accounts, which was viewed as a way to discourage risky behavior by banks as they competed to pay high interest rates.
- Forbade bank officers from borrowing from their own financial institutions.
- Established the Federal Open Market Committee (FOMC).
- Created the Federal Deposit Insurance Corporation (FDIC).
The creation of the FDIC was important for the people of the 1930s, as a common feature of the economic collapse they were facing was bank runs. People would get worried their deposits would disappear, thanks to risky investments their banks were making, and would hurry to liquidate their accounts.
When enough people did this, it fulfilled the banks’ worst fears, removing the capital the financial institutions needed in order to operate. By creating the FDIC, the Glass-Steagall Act gave American depositors faith that their money would still be there, ending bank runs, insuring funds deposited up to $2,500 at time of establishment on Jan. 1, 1934 (today the limit is 100 times as high). Steagall was heavily influential in getting this part of legislation into the bill in exchange for his support and sponsorship.
How the Glass-Steagall Act impacted the banking industry — then and now
The bill took over a year to make it through Congress. After a particularly bad scare in 1933, newly-elected President Franklin Delano Roosevelt was forced to call an emergency national bank holiday in order to prevent a slew of bank runs. After that, the bill passed within a day and was signed into law.
According to public policy organization Demos, the bill was extremely effective. The assurance the FDIC provided to consumers effectively ended bank runs, and the wall between commercial and investment banking reestablished trust in the U.S. equities market.
Today, we still live under the benefit of many provisions of Glass-Steagall. The FDIC lives on and insures accounts up to $250,000 per account holder and account type. And while the FOMC has had some of its rules altered, it continues to set monetary policy in the U.S.
However, the proverbial wall preventing the operation of commercial and investment banking under the same entity was effectively removed by legislation passed in 1999.
Glass-Steagall Act vs Gramm-Leach-Bliley Act
In the latter part of the 20th century, deregulation was the name of the game. According to Douglas Branson, Professor Emeritus of Law at the University of Pittsburgh and author of The Future of Tech is Female, banks began to take advantage of loopholes in the law as a culture of deregulation permeated the American financial industry in the 1980s.
“Financial securities started moving into banking, offering money market checking accounts,” said Branson. “For example, you might be able to open a money market account at Merrill Lynch with 7% returns. Banks had fixed returns — they couldn’t pay more than 4.5%. And so we saw banking services syphoned off by securities firms.”
Throughout the 1970s and into the 1990s, states started allowing bank holding companies to purchase smaller, state-chartered financial institutions. This is not necessarily a bad thing, but did reflect the culture of deregulation and consolidation which encouraged what happened next.
In 1999, the Gramm-Leach-Bliley Act was passed. This law weakened the Glass-Steagall Act by creating financial holding companies (FHCs), which boil down to parent companies which can then own different type of financial institutions. One of these institutions might be a commercial bank, while another can be a securities firm, effectively removing the barriers between commercial and investment banking that were established by Glass-Steagall.
Will the Glass-Steagall Act make a comeback?
Prior to the Great Recession, asset-backed securities became a popular investment for financial organizations, according to Branson.
“When we did away with Glass-Steagall, the banks took that as a green light to just go whole hog in the securities business,” he said.
He went on to explain that mortgages were commonly seen as an extremely safe asset-backed investment, so financial organizations would package them together, place them in an offshore trust or LLC, and then purchase them as securities.
Because of this fact, some blame the financial crisis of 2007-2009 on the Gramm-Leach-Bliley Act’s effective repeal of Glass-Steagall’s firewall between investment and commercial banking.
Sharon Murphy, Professor of History at Providence College, isn’t sure that’s a fair assessment.
“A lot of people who defend deregulation point to the fact that 2008 did not start directly with the types of institutions that benefited most from Gramm-Leach-Bliley,” she said. “That’s true, but on the other hand it exacerbated it.”
Murphy also noted that this exacerbation is the reason some politicians, like Elizabeth Warren, have become advocates of reinstating the Glass-Steagall Act. There is a fear that the recession of 2007-2009 was not the last financial crisis we will see in our lifetimes, and the separation of investment and commercial banking could serve to protect our personal and national economies.
Murphy doesn’t see a new version of the Glass-Steagall Act passing any time soon, though, as she considers our government too polarized at this moment in time.
“There was bipartisan support for a measure like this, with Republicans like John McCain signing on,” said Murphy. “It’s not just a lefty kind of idea. But in this partisan moment, it’s become more about who is promoting the legislation rather than what the legislation is.”