The Glass-Steagall Act, a piece of legislation passed in 1933 in response to the Great Depression, has been a topic of much debate and discussion for decades. The act was enacted in an effort to restore public confidence in the banking sector, which had been severely shaken by the bankruptcy of thousands of banks during the first years of the depression. The legislation aimed to separate investment and deposit banks, with the idea being that by separating these two types of banking, it would reduce the risks associated with investment banking and prevent another economic crisis. This separation allowed banks that managed customer accounts and provided loans to be protected from the more speculative and riskier activities of investment banks. The Glass-Steagall Act not only created a firewall between these two types of banks, but also enabled the insurance sector to separate from banking making it a cornerstone of financial regulation in the United States for several decades.
Glass-Steagall Act Regulations
In addition to being speculative in the pre-depression era, commercial banks organized the sale of stocks called public offerings. That is caused banks to take more significant risks for bigger gains. Glass-Steagall Act aimed to prevent the risk activities of commercial banks. It encouraged the government to provide deposit insurance to banks and ensured that these banks were supported. Thus, it enabled investment banking without risking deposit accounts and prevented significant economic crises.
Under the Glass-Steagall Act, commercial banks were also prohibited from participating in securities underwriting. This restriction was put in place to reduce the risk of banks becoming too heavily invested in speculative securities, which could cause them to fail if the market turned against them. The act also set restrictions on the types of securities that banks could own, limiting them to safe and conservative investments that would not put customer deposits at risk.
The act also established strict limitations on the interlocking of directors between banks and affiliated companies, further reducing the risk of conflicts of interest and ensuring that banks were not using customer deposits to benefit their own interests.
Another important aspect of the Glass-Steagall Act was the creation of the Federal Reserve System's open market committee. This committee was tasked with enforcing regulations and ensuring that banks were operating in a safe and sound manner. The Federal Reserve was given the power to regulate retail banks, and the open market committee was established to provide a centralized and unified voice for regulatory enforcement.
The Glass-Steagall Act also forbade investment banks from having controlling shares in deposit banks. This was to prevent investment banks from using the more secure and stable deposit accounts of retail banks to fund their more speculative activities. By separating these two types of banks, the act helped to create a safer and more stable financial system, which was essential to restoring public confidence in the banking sector.
History of Glass-Steagall Act
The Great Depression of the 1930s had a profound impact on the global economy, and one of its most significant consequences was the loss of public trust in the banking sector. In the years leading up to the Great Depression, commercial banks had engaged in speculative practices, such as the organized sale of stocks in public offerings, which led to greater risks for banks and a decline in public confidence. To restore public trust in the banking sector and prevent similar economic crises in the future, the Glass-Steagall Act was introduced in January 1932 by US Senator Carter Glass, a Democrat from Virginia.
The Glass-Steagall Act was designed to separate commercial and investment banking and prevent commercial banks from engaging in speculative activities that could put depositors' funds at risk. The act was passed by the Senate in May 1933 and signed into law by President Roosevelt on June 16, 1933. The Glass-Steagall Act created a safety net for depositors by requiring the government to provide deposit insurance to banks and ensuring that these banks were supported. In addition, the act gave the Federal Reserve the power to regulate retail banks, created a Federal open market committee to enforce regulations, and prohibited investment banks from having controlling shares in deposit banks.
However, by the 1970s, large banks began to challenge the Glass-Steagall Act's regulations, arguing that they reduced their competitiveness with foreign securities firms. In 1987, Federal Reserve Chairman Alan Greenspan supported the idea that allowing banks to make investment strategies could increase customer income and prevent risky activities. This shift in thinking created ambiguity in the law, leading to violations of the limits set by the Glass-Steagall Act. As a result, the act was repealed in 1999.
The repeal of the Glass-Steagall Act was widely criticized following the 2008-2009 banking crisis, which raised questions about the role of banks in the economy and the need for stricter regulation. In response, Congress enacted the Volcker Rule, part of the Dodd-Frank Act, in 2010 to revive the impact of the Glass-Steagall Act. The Volcker Rule imposed restrictions on banks' ability to use depositors' funds for risky investments, but it did not require them to change their organizational structure. If a bank is large enough to pose a threat to the economy, the Dodd-Frank Federal Reserve will need regulations to ensure its stability.
The Federal Deposit Insurance Corporation (FDIC) The Glass-Steagall Act, enacted in 1933, aimed to create a safety net for the banking system by separating commercial banks and investment banks. As a result of this separation, FDIC was created to protect customer deposits at commercial banks. The FDIC is responsible for ensuring the security of the money you deposit in a bank by guaranteeing that deposits are insured up to a specified amount.
When banks apply deposits to generate income through investments, such as loans and stocks, there is a risk that these investments may not meet customer demands or perform poorly. In these cases, the FDIC steps in to protect the customer's investment.
The Future of the Glass-Steagall Act and the Volcker Rule The Glass-Steagall Act has been the subject of much debate in recent years, with some calling for its return to prevent risky banking activities and potential financial crises. Following the 2008-2009 financial crisis, there have been significant efforts to restructure the banking sector, and as a result, Congress enacted the Volcker Rule as part of the Dodd-Frank Act in 2010.
The Volcker Rule aims to revive the impact of the Glass-Steagall laws by imposing restrictions on a bank's ability to use depositors' funds for risky investments. This rule does not require banks to change their organizational structure but requires large banks to adhere to regulations set by the Federal Reserve if they are deemed too big to fail.