What was the 'Glass-Steagall Act'
An act the U.S. Congress passed in 1933 as the Banking Act, which prohibited commercial banks from participating in the investment banking business. The Glass-Steagall Act was sponsored by Senator Carter Glass, a former Treasury secretary, and Rep. Henry Steagall, a member of the House of Representatives and chairman of the House Banking and Currency Committee. The Act was passed as an emergency measure to counter the failure of almost 5,000 banks during the Great Depression. The Glass-Steagall lost its potency in subsequent decades and was partially repealed in 1999.
BREAKING DOWN 'Glass-Steagall Act'
Apart from separating commercial and investment banking, the Glass-Steagall Act also created the Federal Deposit Insurance Corporation (FDIC), which guaranteed bank deposits up to a specified limit. The Act also created the Federal Open Market Committee (FOMC) and introduced Regulation Q, which prohibited banks from paying interest on demand deposits and capped interest rates on other deposit products (it was repealed in July 2011).
The Glass-Steagall Act's primary objectives were twofold – to stop the unprecedented run on banks and restore public confidence in the U.S. banking system; and to sever the linkages between commercial and investment banking that were believed to have been responsible for the 1929 market crash. The rationale for seeking the separation was the conflict of interest that arose when banks were engaged in both commercial and investment banking, and the tendency of such banks to engage in excessively speculative activity.
The Glass-Steagall Act's partial repeal in 1999 by the Graham-Leach-Bliley Act (GLBA) is believed in some circles to have contributed to the 2008 global credit crisis. Commercial banks, around the world, were saddled with billions of dollars in losses due to the excessive exposure of their investment banking arms to derivatives and securities that were tied to U.S. home prices. The severity of the crisis forced Goldman Sachs and Morgan Stanley, the last of the top-tier independent investment banks, to convert to bank holding companies. Coupled with the acquisition of other prominent investment banks Bear Stearns and Merrill Lynch by commercial banking giants JP Morgan and Bank of America, respectively, the 2008 developments ironically signaled the final demise of the Glass-Steagall Act.
During the 2016 presidential campaign, Donald Trump inferred the reinstatement of the Glass-Steagall Act. After his election to the presidential seat in 2017, his head of the National Economic Council, Gary Cohn, revived talks of restoring the Act to break up the big banks. Cohn’s stance prompted senators in support of the idea like John McCain and Elizabeth Warren to initiate a draft for the 21st Century Glass-Steagall Act bill. The bill will institute a separation of traditional banking from investment banks, hedge funds, insurance, and private equity activities within a five-year transition period. By creating a wall between commercial banking activities and riskier financial institutions, ‘too big to fail’ banks will be forced to shrink in size, making them smaller and more secure for depositors, the financial sector, and the economy. Breaking up the large banks, which have been found to be larger in 2017 than they were before the 2008 financial crisis, will mitigate the risks of a government bailout in the future.