ECONOMY

Glass Steagall Act of 1933: Its purpose and repeal

The Glass-Steagall Act of 1933 separated investment banking and retail banks. 1 Investment banking organized initial stock sales, also known as an initial public offer. They also facilitated mergers, acquisitions, and other transactions. They operated hedge funds. Retail banks accepted deposits, managed checking account, and made loans.

Retail banks could only earn 10% of their income from selling securities. Government bonds could be underwritten by retail banks, but only 10% of their revenue could come from securities. The act was most important for depositors because it created the Federal Deposit Insurance Corporation.

It gave the Federal Reserve the power to regulate retail banks. 1 The Federal Open Market Committee was created, which allowed the Fed to better implement the monetary policy. 2

Glass-Steagall prevented investment banks from owning a controlling stake in retail banks. They were forced to find a source of funding other than depositors’ accounts. 4

The law prohibits bank officials from borrowing excessively on their own account.

It introduced Regulation Q. The act prohibited banks from paying interest to checking accounts. The Fed was also able to set a ceiling on the interest rate paid on other types of deposits.

Glass-Steagall is officially known as the Banking Act of 1933 (48 Stat. 162). 6

 

The Passage

Glass-Steagall passed the House of Representatives in May 1933. The Senate passed it on May 25, 1934. The President Roosevelt signed it into law on June 16, 1933 as part of his New Deal.

After the law was passed, banks were given one year to decide if they wanted to become investment banks or commercial banks.

 

Purpose

Glass-Steagall was designed to end bank runs, and the unsafe bank practices that led to them. Congress passed Glass-Steagall in order to reform a banking system that had allowed 4,000 banks to fail during the Great Depression. The bill was debated in 1932. 2 This bill redirected funds from the banks to build industrial capacity instead of fueling stock speculation.

Banks have invested in stocks since 1922. In 1929, when the stock market crashed, depositors were rushing to withdraw their money. In just four weeks, they had already withdrawn 1,78 billion dollars by March 8. Other people demanded gold as payment. The United States still adhered to the Gold Standard but demand was so great that the Federal Reserve ran out of gold.

Even sound banks will be forced out of business by a bank run. Banks only keep a tenth of the deposits they have on hand, and then lend out the remainder. They only need to find 10% of their deposits in order to satisfy depositors.

The Emergency Banking Act was passed by Congress on March 9. The Emergency Banking Act allowed the banks to reopen March 13, 1933. The banks would no longer be able to exchange dollars for precious metals. The Federal Reserve instead printed dollars to satisfy depositors. The currency was created based on bank paper assets. By March 15, the majority of banks were reopening and found that the run on the banks was over. 13

 

The Effect of Using

Glass-Steagall brought back confidence in the U.S. Banking System. The trust was increased by allowing only safe investments to be made with depositor funds. The FDIC program protected banks from further bank runs. The FDIC insurance program protected depositors from bank failures.

During the Reagan Administration, the banking industry complained about the Act restricting them too much. They claimed they could not compete with foreign firms who offered higher returns. They could only invest in low risk securities. By diversifying their businesses, they wanted to maximize their return and lower the risk of their customers.

Citigroup began merger talks with Travelers Insurance before Glass-Steagall. In 1998 it announced a successful merger with a new company named Citigroup.

 

Repeal

The Financial Services Modernization Act was signed by President Clinton on November 12, 1999. It repealed Glass-Steagall.

Glass-Steagall repealed consolidated investment banks and retail banks into financial holding companies. The Federal Reserve supervises the new entities. Few banks took advantage because of this. The majority of Wall Street banks didn’t want to be subjected to additional capital and supervision requirements.

The ones that didn’t became too large to fail. It was necessary to bail them out in 2008 and 2009 to avoid another recession.

 

Should Glass-Steagall be Reinstated?

Restoring Glass-Steagall will better protect the depositors. It would also disrupt the bank’s structures. The banks would not be too large to fail but their growth could be slowed as they reorganized.

The efforts of the Congressional to reinstate Glass Steagall were not successful. H.R. 1489 was introduced in 2011 to repeal the Gramm-Leach-Bliley Act and reinstate Glass Steagall. In 2011, H.R. Citibank and Goldman Sachs are two of the largest banks.

The banks claimed that reinstating Glass-Steagall will make them too small for global competition. 21

It doesn’t require that they change their organization structure. Dodd-Frank stipulates that if a bank threatens to destroy the U.S. economic system, it must be more closely regulated by the Federal Reserve.

 

FAQs (Frequently Asked Questions)

Who repealed Glass-Steagall Act?

Bill Clinton repealed parts of the Glass-Steagall Act, 1999. Both Democrats and Republicans voted in favor of repealing the Glass-Steagall Act. Seven Democrats, one Republican and two Republicans voted against repeal.

 

What is the Glass-Steagall Act and how does it affect Americans today

Some provisions of the Glass-Steagall Act remain in effect, even though significant portions were repealed by 1999. Savings accounts, for example, still receive FDIC Insurance. The FDIC insurance was controversial at the time. However, Rep. Henry Steagall made sure to include it in the bill. It is still in place today.

the authorAaron Krause

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