The Birth of the Glass-Steagall Act: A Response to Crisis
The Glass-Steagall Act of 1933 was implemented to separate commercial banking from investment banking. The legislation aimed to shield depositors from potential losses due to risky stock market speculation, ultimately responding to the catastrophic 1929 stock market crash and subsequent wave of commercial bank failures.
Signed into law by President Franklin Delano Roosevelt on June 16, 1933, as part of the New Deal, it became a fixture in U.S. banking regulation until its repeal in 1999. One long-standing provision still in effect today is the Federal Deposit Insurance Corporation (FDIC), which continues to guarantee individual deposits.
###** Key Takeaways
- Passed in 1933, the Glass-Steagall Act segregated commercial banking activities from investment banking to mitigate risks associated with stock market investments.
- The Act was seen as a preventive measure against speculative banking practices widely considered contributors to the Great Depression.
- Banks had to choose between offering commercial or investment banking services.
- The Gramm-Leach-Bliley Act in 1999 repealed major Glass-Steagall provisions, a move some attribute to the 2008 financial crisis.
Provisions of the Glass-Steagall Act: Safeguarding the Economy
In the era before the Great Depression, banks frequently engaged in speculative investments. The Glass-Steagall Act put a regulatory barrier between commercial and investment banking endeavors. Named after Senator Carter Glass and Representative Henry Bascom Steagall, key provisions of the Act included:
- Separation of Banking Functions: Banks had to specialize in either commercial or investment banking. Up to 10% of a commercial bank’s income could come from securities, with an exception for underwriting government bonds.
- Establishment of the FDIC: An amendment created the FDIC to insure individual deposits.
- Regulations on Retail Banks: Allowed the Federal Reserve to regulate retail banks directly.
- Introduction of the Federal Open Market Committee (FOMC): Established to influence monetary policy.
The Impact on the Banking Sector: By Design and by Necessity
The Glass-Steagall Act compelled prominent banks such as JP Morgan and Company to streamline their services and diversify income sources. This separation was intended to curb the misuse of deposits for risky speculations and prevent underwriting insolvencies.
An extension of the Act, the Bank Holding Company Act of 1956, further defined the regulatory landscape by regulating companies holding 25% or more shares in two or more banks, granting the Federal Reserve greater oversight.
The Repeal of Glass-Steagall and the Gramm-Leach-Bliley Act: Change and Controversy
The limitations imposed by Glass-Steagall spurred debates. While some argued for the diversification of banking activities to mitigate risks, others believed Glass-Steagall stifled economic growth. Amid these controversies, Congress repealed the Act’s significant provisions in 1999, with the Gramm-Leach-Bliley Act allowing affiliations between commercial and investment banks. However, the FDIC provision remained intact.
Financial Crisis After Repeal: A Looming Shadow
Speculative and risky activities surged following the repeal, leading many economists to link it to the 2008 financial crisis triggered predominantly by the collapse of the subprime mortgage market.
Fast-forward to 2023, the Federal Reserve acted to fortify confidence in the banking system following Silicon Valley Bank’s collapse, highlighting ongoing regulatory challenges in the sector.
Frequently Asked Questions about the Glass-Steagall Act
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What Was the Purpose of the Glass-Steagall Act?
The Act aimed to separate commercial and investment banking activities, addressing issues following the 1929 stock market crash.
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Is the Glass-Steagall Act Still in Effect?
No, it was largely repealed in 1999. However, the FDIC provision remains in place.
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Why Was the Glass-Steagall Act Repealed?
Concerns that it stifled banking sector growth and that diversified banking activities would mitigate risks led to its repeal.
The Bottom Line: Reflections on Glass-Steagall’s Legacy
The Glass-Steagall Act played a crucial role in separating commercial banks from speculative ventures to avert financial crises akin to those experienced in the Great Depression. While it faced criticism leading to its repeal in 1999, the Act’s legacy endures through ongoing debates on banking regulations and financial stability.
Related Terms: commercial banking, investment banking, FDIC, financial regulation, New Deal, Banking Act of 1933
References
- Federal Reserve Bank of Philadelphia. “40 Years of the Federal Reserve Act”,
- Federal Reserve Bank of St. Louis. “Banking Act of 1933 (Glass-Steagall Act)”.
- Federal Deposit Insurance Corporation. “History of the U.S. Banking Industry and Deposit Insurance Timeline.”
- United States House of Representatives. “Engrossed Copy of Glass–Steagall Act”.
- Congressional Research Service. “The Glass-Steagall Act: A Legal and Policy Analysis”, Pages 5-7.
- Federal Reserve History. “Bank Holding Company Act of 1956”.
- U.S. Department of the Treasury. “Statement by President Bill Clinton at the Signing of the Financial Modernization Bill”.
- GovTrack. “S. 900 (106th): Gramm-Leach-Bliley Act”.
- University of California, Berkeley Institute on Research for Labor and Employment. “What Really Caused the Great Recession”?
- SIFMA. “Senate Finance Committee on the President’s 2024 Budget”.
