Consequences of the Glass-Steagall Act Repeal

Despite its tendency to be scapegoated, the repeal of the Glass-Steagall Act was, at most, a minor contributor to the financial crisis. Although the repeal allowed much bigger banks, it can't be blamed for the crisis. The heart of the 2008 crisis was nearly $5 trillion worth of basically worthless mortgage loans, among other factors.

Key Takeaways

  • Repealing the Glass-Steagall Act could be considered a factor in the 2008 financial crisis.
  • Some financial experts believed that the repeal of the Glass-Steagall Act allowed banks to grow too big.
  • The Glass-Steagall Act prevented banks from operating as both commercial and investment banks.
  • Its repeal was only one of many factors that contributed to the meltdown in the housing market.
  • Unscrupulous lending practices were a major contributor to the 2008 financial crisis.

Why Glass-Steagall Is Not (Entirely) to Blame

Since non-bank lenders originated the overwhelming majority of subprime mortgages, and the buyers of over half of them in the 10 years leading up to the 2008 crisis were not banks—commercial or investment—but Fannie Mae and Freddie Mac, pointing the finger at this particular banking regulation is not warranted.

Some argue that the repeal of the Glass-Steagall Act of 1933 caused the financial crisis because banks were no longer prevented from operating as both commercial and investment banks, and the repeal allowed banks to become substantially larger or "too big to fail."

However, the crisis would likely have happened even without the Glass-Steagall repeal. Some argue it may have been on a smaller scale, and that may be true, but the repeal was only one of many straws that broke the proverbial camel's back.

2008

The financial crisis was caused in part by dysfunctional lending practices and subprime mortgages.

How the Glass-Steagall Act's Repeal Impacted the Financial Crisis

The repeal of the Glass-Steagall Act did impact the financial crisis in some ways because the repeal allowed for the consolidation of investment and retail banks via financial holding companies. This consolidation led to a few bloated financial institutions, like Bear Stearns, heavily invested in mortgage-backed securities.

During the crisis, many of the institutions had to be helped by the federal government. In this way, the act's repeal played a role in the crisis because, in the past, the law kept financial institutions from becoming investment and commercial banks.

The Glass-Steagall Act was partially repealed In 1999 as part of the Gramm-Leach-Bliley Act.

Subprime Mortgage-backed Securities and their Inevitable Implosion

Glass-Steagall applied to banks, and although many mortgage-backed derivatives were created and sold by banks, subprime mortgages—the underlying assets of the derivatives—were initially issued by non-bank lenders. Glass-Steagall would not have prevented these initial loans. In addition, investment banks such as Lehman Brothers, Bear Stearns, and Goldman Sachs, who were all major players in the subprime mortgage meltdown, never ventured into commercial banking.

They were investment banks, just as before Glass-Steagall was repealed. The lack of mortgage requirements led to a lot of people getting mortgages they couldn't afford, making large-scale defaults inevitable.

The root cause of the financial crisis was the subprime mortgage meltdown. The Department of Housing and Urban Development (HUD) is at the heart of that problem, which required Fannie Mae and Freddie Mac to purchase more "affordable" mortgages to encourage lenders to make loans to low-income and minority borrowers.

To meet HUD's goals, lenders began to institute policies such as foregoing any requirement for a down payment and accepting unemployment benefits as a qualifying source of income. (Again, most of these lenders were private mortgage lenders, not banks, so the Glass-Steagall Act didn't apply to them.) Several contributing factors were to the financial crisis, and partial blame can be assigned to deregulation. However, the repeal of the Glass-Steagall Act played at most a minor role in the crisis.

Did the 1999 Repeal of the Glass-Steagall Act Contribute to the 2008 Recession?

The repeal of the Glass-Steagall Act may have contributed in part to the 2008 Recession as it allowed banks to become both commercial and investment entities.

What President Repealed the Glass-Steagall Act?

On November 12, 1999, President Bill Clinton signed a law, the Gramm-Leach-Bliley Act, and this law repealed some of the provisions of the Glass-Steagall Act but it wasn't a full repeal of the bill.

Was the U.S. Government To Blame for the Great Recession?

There were many contributing factors that caused the Great Recession, including banks that were both investing and commercial institutions, a subprime mortgage crisis caused by some unscrupulous lending practices.

What Did the Gramm-Leach-Bliley Act Overturn?

The Gramm-Leach-Bliley Act overturned parts of the Glass-Steagall Act.

Was the U.S. Government To Blame for the Great Recession?

No. The Great Recession was caused mainly by the subprime mortgage lending crisis and the subsequent collapse of the housing market.

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