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

Key Takeaways

  • Repealing the Glass-Steagall Act, which effectively let banks become even larger, could be considered a factor of the 2008 financial crisis.
  • However, it is only one of many factors that contributed to the meltdown in the housing market. Unscrupulous lending practices were a much larger contributor.

Subprime Morthgage-backed Securities and their Inevitable Implosion

Glass-Steagall applied to banks, and although many of mortgage-backed derivatives were created and sold by banks, subprime mortgages—the underlying assets of the derivatives—were originally issued by non-bank lenders, and these initial loans would not have been prevented by Glass-Steagall. 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 They were investment banks, just as they had been before Glass-Steagall was repealed.

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

The lack of requirements for mortgages led to a lot of people getting mortgages they couldn't afford, making large-scale defaults inevitable. 

In order 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, the majority of these lenders were private mortgage lenders, not banks, so the Glass-Steagall Act didn't apply to them).

There were a number of contributing factors to the financial crisis, and partial blame can be assigned to deregulation. The repeal of the Glass-Steagall Act, however, played at most a minor role in the crisis.