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.

Investopedia Says:
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Established in 1933 and repealed in 1999, the Glass-Steagall Act had good intentions but mixed results.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 The Gramm-Leach-Bliley Act repealed the affiliation (Section 20) and management interlock (section 32) prohibitions of Glass-Steagall.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.

This article may require cleanup to meet Wikipedia's quality standards. Please improve this article if you can. (July 2007)

Glass-Steagall Act

Full title	Banking Act of 1933
Acronym / colloquial name	Glass-Steagall Act
Enacted by the	73rd United States Congress
Effective	June 16, 1934
Citations
U.S. Statutes at Large	48 Stat. 162 (1933)
Codification
Legislative history
Introduced in the House of Representatives as H.R. 5661 by Rep. Henry B. Steagall (D-AL) on Signed into law by President Franklin Delano Roosevelt on June 16, 1933
Major amendments
American Homeownership and Economic Opportunity Act, Gramm-Leach-Bliley Act, Depository Institutions Deregulation and Monetary Control Act

The Glass-Steagall Act of 1933 established the Federal Deposit Insurance Corporation (FDIC) in the United States and included banking reforms, some of which were designed to control speculation.^[1] Some provisions such as Regulation Q, which allowed the Federal Reserve to regulate interest rates in savings accounts, were repealed by the Depository Institutions Deregulation and Monetary Control Act of 1980. Provisions that prohibit a bank holding company from owning other financial companies were repealed on November 12, 1999, by the Gramm-Leach-Bliley Act.^[2][3]

Contents 1 Background 2 First Glass-Steagall Act 3 Second Glass-Steagall Act 3.1 Impact on other countries 4 Repeal of the Act 4.1 Financial events following the repeal 5 See also 6 References 7 External links

Background

Two separate United States laws are known as the Glass-Steagall Act.

Both bills were sponsored by Democratic Senator Carter Glass of Lynchburg, Virginia, a former Secretary of the Treasury, and Democratic Congressman Henry B. Steagall of Alabama, Chairman of the House Committee on Banking and Currency.

The first Glass-Steagall Act was passed in February 1932 in an effort to stop deflation and expanded the Federal Reserve's ability to offer rediscounts on more types of assets such as government bonds as well as commercial paper.^[4] The second Glass-Steagall Act was passed in 1933 in reaction to the collapse of a large portion of the American commercial banking system in early 1933.

Although Republican President Herbert Hoover had lost reelection in November 1932 to Democratic Governor Franklin D. Roosevelt of New York, the administration did not change hands until March 1933. The lame-duck Hoover Administration and the incoming Roosevelt Administration could not, or would not, coordinate actions to stop the run on banks affiliated with the Henry Ford family that began in Detroit, Michigan, in January 1933. Federal Reserve chairman Eugene Meyer was equally ineffectual.

While many economic historians attribute the collapse to the economic problems which followed the Stock Market Crash of 1929, some economists attribute the collapse to gold-backed currency withdrawals by foreigners who had lost confidence in the dollar and by domestic depositors who feared that the United States would go off the gold standard,^[5] which it did when Roosevelt signed Executive Order 6102, The Gold Confiscation Act of April 5, 1933.^[6]

According to a summary by the Congressional Research Service of the Library of Congress:

“

In the nineteenth and early twentieth centuries, bankers and brokers were sometimes indistinguishable. Then, in the Great Depression after 1929, Congress examined the mixing of the “commercial” and “investment” banking industries that occurred in the 1920s. Hearings revealed conflicts of interest and fraud in some banking institutions’ securities activities. A formidable barrier to the mixing of these activities was then set up by the Glass Steagall Act.[7]

”

First Glass-Steagall Act

The first Glass-Steagall Act was the first time that currency (non-specie, paper currency etc.) was permitted to be allocated for the Federal Reserve System.

Second Glass-Steagall Act

The second Glass-Steagall Act, passed on June 16, 1933, and officially named the Banking Act of 1933, introduced the separation of bank types according to their business (commercial and investment banking), and it founded the Federal Deposit Insurance Corporation for insuring bank deposits. Literature in economics usually refers to this simply as the Glass-Steagall Act, since it had a stronger impact on US banking regulation.^[8]

Impact on other countries

The Glass-Steagall Act has had influence on the financial systems of other areas such as China which maintains a separation between commercial banking and the securities industries.^[9][10] In the aftermath of the financial panic of 2008-9, support for maintaining China's separation of investment and commercial banking remains strong.^[11]

Repeal of the Act

See also Depository Institutions Deregulation and Monetary Control Act of 1980, the Garn-St. Germain Depository Institutions Act of 1982, and the Gramm-Leach-Bliley Act of 1999.

The bill that ultimately repealed the Act was introduced in the Senate by Phil Gramm (Republican of Texas) and in the House of Representatives by Jim Leach (R-Iowa) in 1999. The bills were passed by Republican majorities on party lines by a 54-44 vote in the Senate^[12] and by a 343-86 vote in the House of Representatives.^[13] After passing both the Senate and House the bill was moved to a conference committee to work out the differences between the Senate and House versions. The final bill resolving the differences was passed in the Senate 90-8 (one not voting) and in the House: 362-57 (15 not voting). The legislation was signed into law by President Bill Clinton on November 12, 1999. ^[14]

The banking industry had been seeking the repeal of Glass-Steagall since at least the 1980s. In 1987 the Congressional Research Service prepared a report which explored the case for preserving Glass-Steagall and the case against preserving the act.^[7]

The argument for preserving Glass-Steagall (as written in 1987):

1. Conflicts of interest characterize the granting of credit — lending — and the use of credit — investing — by the same entity, which led to abuses that originally produced the Act.

2. Depository institutions possess enormous financial power, by virtue of their control of other people’s money; its extent must be limited to ensure soundness and competition in the market for funds, whether loans or investments.

3. Securities activities can be risky, leading to enormous losses. Such losses could threaten the integrity of deposits. In turn, the Government insures deposits and could be required to pay large sums if depository institutions were to collapse as the result of securities losses.

4. Depository institutions are supposed to be managed to limit risk. Their managers thus may not be conditioned to operate prudently in more speculative securities businesses. An example is the crash of real estate investment trusts sponsored by bank holding companies (in the 1970s and 1980s).

The argument against preserving the Act (as written in 1987):

1. Depository institutions will now operate in “deregulated” financial markets in which distinctions between loans, securities, and deposits are not well drawn. They are losing market shares to securities firms that are not so strictly regulated, and to foreign financial institutions operating without much restriction from the Act.

2. Conflicts of interest can be prevented by enforcing legislation against them, and by separating the lending and credit functions through forming distinctly separate subsidiaries of financial firms.

3. The securities activities that depository institutions are seeking are both low-risk by their very nature, and would reduce the total risk of organizations offering them -- by diversification.

4. In much of the rest of the world, depository institutions operate simultaneously and successfully in both banking and securities markets. Lessons learned from their experience can be applied to our national financial structure and regulation.^[7]

Financial events following the repeal

The repeal enabled commercial lenders such as Citigroup, which was in 1999 the largest U.S. bank by assets, to underwrite and trade instruments such as mortgage-backed securities and collateralized debt obligations and establish so-called structured investment vehicles, or SIVs, that bought those securities.^[15] Elizabeth Warren,^[16] co-author of All Your Worth: The Ultimate Lifetime Money Plan (Free Press, 2005) (ISBN 0-7432-6987-X) and one of the five outside experts who constitute the Congressional Oversight Panel of the Troubled Asset Relief Program, has said that the repeal of this act contributed to the Global financial crisis of 2008–2009,^{[17] [18]} although some believe that the increased flexibility allowed by the repeal of Glass-Steagall mitigated or prevented the failure of some American banks.^[19]

This section contains information which may be of unclear or questionable importance or relevance to the article's subject matter. Please help improve this article by clarifying or removing superfluous information.

The year before the repeal, sub-prime loans were just five percent of all mortgage lending.^{[citation needed]} By the time the credit crisis peaked in 2008, they were approaching 30 percent.^{[citation needed]} This correlation is not necessarily an indication of causation, however, as there are several other significant events that have impacted the sub-prime market during that time. These include the adoption of mark-to-market accounting, implementation of the Basel Accords, the rise of adjustable rate mortgages etc. ^[20]

See also

• Subprime mortgage crisis
• Global financial crisis of 2008

References

1. ^ "Frontline: The Wall Street Fix: Mr. Weill Goes to Washington: The Long Demise of Glass-Steagall". www.pbs.org. PBS. 2003-05-08. http://www.pbs.org/wgbh/pages/frontline/shows/wallstreet/weill/demise.html. Retrieved on 2008-10-08. 
2. ^ "The Repeal of Glass-Steagall and the Advent of Broad Banking" (PDF). http://www.occ.treas.gov/ftp/workpaper/wp2000-5.pdf. 
3. ^ "GRAMM'S STATEMENT AT SIGNING CEREMONY FOR GRAMM-LEACH-BLILEY ACT". http://banking.senate.gov/prel99/1112gbl.htm. 
4. ^ http://mises.org/rothbard/agd/chapter11.asp
5. ^ http://mises.org/rothbard/agd/chapter12.asp
6. ^ Gold Confiscation Act, http://www.the-privateer.com/1933-gold-confiscation.html 
7. ^ ^{a b c} http://digital.library.unt.edu/govdocs/crs/permalink/meta-crs-9065:1
8. ^ "FDIC: Important Banking Legislation". http://www.fdic.gov/regulations/laws/important/index.html. 
9. ^ (PDF) Developing Institutional Investors in the People's Republic of China, paragraph 24, http://www.worldbank.org.cn/english/content/insinvnote.pdf 
10. ^ Langlois, John D. (2001), "The WTO and China's Financial System", China Quarterly 167: 610–629, doi:10.1017/S0009443901000341 
11. ^ "China to stick with US bonds", The Financial Times (paragraph 9), http://www.ft.com/cms/s/0/ba857be6-f88f-11dd-aae8-000077b07658.html, retrieved on 2009-02-11 
12. ^ On Passage of the Bill (S.900 as amended ), http://www.senate.gov/legislative/LIS/roll_call_lists/roll_call_vote_cfm.cfm?congress=106&session=1&vote=00105, retrieved on 2008-06-19 
13. ^ On Agreeing to the Conference Report - Financial Services Modernization Act, http://clerk.house.gov/evs/1999/roll276.xml, retrieved on 2008-06-19 
14. ^ http://www.govtrack.us/congress/bill.xpd?bill=s106-900#votes
15. ^ Barth et al. (2000). "Policy Watch: The Repeal of Glass-Steagall and the Advent of Broad Banking" (PDF). Journal of Economic Perspectives 14 (2): 191–204. http://www.occ.treas.gov/ftp/workpaper/wp2000-5.pdf. 
16. ^ http://www.thedailyshow.com/video/index.jhtml?videoId=224262&title=elizabeth-warren-pt.-2&byDate=true
17. ^ http://www.telegraph.co.uk/finance/comment/liamhalligan/4623601/Outrage-at-bonuses-wont-solve-the-mess-were-in.html
18. ^ Who's More to Blame: Wall Street or the Repealers of the Glass-Steagall Act?, http://www.fool.com/investing/general/2009/04/06/whos-more-to-blame-wall-street-or-the-repealers-of.aspx?source=ihpsitcl10000001, retrieved on 2009-04-07 
19. ^ http://meganmcardle.theatlantic.com/archives/2008/09/hindsight_regulation.php
20. ^ The Subprime Mortgage Market Collapse:A Primer on the Causes and Possible Solutions http://www.heritage.org/research/economy/bg2127.cfm

External links

• Glass-Steagall Act - Further Readings
• On the systematic dismemberment of the Act from PBS Frontline
• Back to the Twenties Through the Looking Glass - Steagall Hour long Wizards of Money MP3 explaining the Glass-Steagall Act, background to it and impact of it.

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