Glass-Steagall Act

An Act passed by Congress in 1933, that prohibited commercial banks from collaborating with full-service brokerage firms or participating in investment banking activities.

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The Glass-Steagall Act was enacted during the Great Depression. It protected bank depositors from the additional risks associated with security transactions. The Act was dismantled in 1999. Consequently, the distinction between commercial banks and brokerage firms has blurred; many banks own brokerage firms and provide investment services.

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Established in 1933 and repealed in 1999, the Glass-Steagall Act had good intentions but mixed results. What Was The Glass-Steagall Act?

Legislation excluding commercial banks that are members of the Federal Reserve System from most types of investment banking activities. The coauthor of the Act, Senator Carter Glass of Virginia, believed that commercial banks should restrict their activities to involvement in short-term loans to coincide with the nature of their primary classification of liabilities, demand deposits. Today, many in the banking field view these constraints as particularly burdensome because of increased competition from other financial institutions for customers' savings and investment dollars.

Federal law enacted by Congress in 1933 forcing a separation between commercial banking and investment banking. This act, which required commercial banks to dispose of their securities affiliates, bears the same name as the Banking Act of 1933, and is part of the landmark 1933 act. Since then, the name Glass-Steagall has been more commonly used when referring to the four sections of the banking act (Sections 16, 20, 21, and 32) pertaining to underwriting and sale of securities.

The late 1980s saw legislative barriers between banking and investment banking significantly eroded, as banks were granted more powers by banking regulators to deal in securities as both principal and agent for bank customers. Commercial banks own securities, broker-dealer and investment management firms, and mutual fund companies, and they act as investment advisors for municipal governments and corporations. Banks won Federal Reserve Board approval to underwrite commercial paper in 1987, and corporate equity securities and bonds in 1990 (through subsidiaries of bank holding companies). The Gramm-Leach-Bliley Act repealed the affiliation (Section 20) and management interlock (section 32) prohibitions of Glass-Steagall.

Other key provisions of the Glass-Steagall Act still remaining in effect are Section 16, prohibiting Federal Reserve Member Banks from directly underwriting securities, except for those of the U.S. Treasury and federal agencies, and the general obligations of state and municipal governments; and Section 21, prohibiting securities underwriters from accepting federally insured deposits. See also Permissible Nonbank Activities; Securities Subsidiary.

Glass-Steagall Act, an emergency banking measure passed by Congress in 1932. Its first two provisions permitted particular member banks to use collateral normally ineligible for rediscount to borrow from Federal Reserve banks at one percent above the rate on normally eligible paper. The act authorized the Federal Reserve Board to permit Federal Reserve banks to use U.S. government obligations, gold, and eligible paper to secure Federal Reserve notes. This act stabilized the banking system only temporarily.

The following year, Congress passed the Glass-Steagall Act of 1933, also called the Banking Act of 1933, which created the Federal Deposit Insurance Corporation and separated investment and commercial banking. Congress repealed the Glass-Steagall Act of 1933 in 1999, with the passing of the Financial Services Modernization Act of 1999 (Gramm-Leach-Bliley Act), thus removing the regulations barring mergers among banking, securities, and insurance businesses.

Bibliography

McElvaine, Robert S. The Great Depression: America 1929–1941. New York: Times Books, 1984; 1993.

—Frederick A. Bradford

Legislation passed by Congress in 1933 that prohibits commercial banks from engaging in the investment business.

The Glass-Steagall Act, also known as the Banking Act of 1933 (48 Stat. 162), was enacted as an emergency response to the failure of nearly five thousand banks during the Great Depression. The act was originally part of President Franklin D. Roosevelt's New Deal program and became a permanent measure in 1945. It gave tighter regulation of national banks to the Federal Reserve System; prohibited bank sales of securities; and created the Federal Deposit Insurance Corporation (FDIC), which insures bank deposits with a pool of money appropriated from banks.

Beginning in the 1900s, commercial banks established security affiliates that floated bond issues and underwrote corporate stock issues. (In underwriting, a bank guarantees to furnish a definite sum of money by a definite date to a business or government entity in return for an issue of bonds or stock.) The expansion of commercial banks into securities underwriting was substantial until the 1929 stock market crash and the subsequent Depression. In 1930 the Bank of the United States failed, reportedly because of activities of its security affiliates that created artificial conditions in the market. In 1933 all the banks throughout the country were closed for a four-day period, and four thousand banks closed permanently.

As a result of the bank closings and already devastated economy, public confidence in the U.S. financial structure was low. To restore the confidence of the U.S. banking public that banks would follow reasonable banking practices, Congress created the Glass-Steagall Act. The act forced a separation of commercial and investment banks by preventing commercial banks from underwriting securities, with the exception of U.S. Treasury and federal agency securities, and municipal and state general obligation securities. More specifically, the act authorizes Federal Reserve banks to use government obligations and commercial paper as collateral for their note issues, in order to encourage expansion of the currency. Banks can also offer advisory services regarding investments for their customers, as well as buy and sell securities for their customers. However, information gained from providing such services cannot be used by a bank when it acts as a lender. Likewise, investment banks cannot engage in the business of receiving deposits.

A bank is defined as an institution organized under the laws of the United States, any state of the United States, the District of Columbia, any territory of the United States, Puerto Rico, Guam, American Samoa, or the Virgin Islands, that both accepts demand deposits (deposits that the depositor may withdraw by check or similar means for payment to third parties or others) and is engaged in the business of making commercial loans (12 U.S.C.A. § 1841 (c)(1) [1988]). Investment banking consists mostly of securities underwriting and related activities; making a market in securities; and setting up corporate mergers, acquisitions, and restructuring. Investment banking also includes services provided by brokers or dealers in transactions in the secondary market. A secondary market is one where securities are bought and sold subsequent to their original issuance.

Despite attempts to reform Glass-Steagall, the legislature has not passed any major changes — although it has passed bills that relax restrictions. Banks may now set up brokerage subsidiaries, and underwrite a limited number of issues such as asset-backed securities, corporate bonds, and commercial paper.

The Glass-Steagall Act restored public confidence in banking practices during the Great Depression. However, many historians believe that the commercial bank securities practices of the time had little actual effect on the already devastated economy and were not a major contributor to the Depression. Some legislators and bank reformers argue that the act was never necessary, or that it has become outdated and should be repealed.

See: Banks and Banking; Federal Reserve Board.