Glass-Steagall Act

What was the 'Glass-Steagall Act'

The Glass-Steagall Act was passed by the U.S. Congress in 1933 as the Banking Act, which prohibited commercial banks from participating in the investment banking business. Glass-Steagall 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. Glass-Steagall lost its potency in subsequent decades and was partially repealed in 1999.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 (It was repealed in July 2011.)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 (e.g. 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 worldwide were saddled with billions of dollars in losses, due to the excessive exposure of their investment banking arms to derivatives and securities, tied to U.S. home prices. The severity of the crisis forced Goldman Sachs and Morgan Stanley, 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 J.P. Morgan and Bank of America, respectively, the 2008 developments signaled the final demise of the Glass-Steagall Act.

Potential Re-Instatement of the Glass-Steagall Act

During the 2016 presidential campaign, Donald Trump hinted at a potential reinstatement of the Glass-Steagall Act. After his election 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, such as John McCain and Elizabeth Warren, to initiate a draft for a 21st Century Glass-Steagall Act bill. The bill would institute a separation of traditional banking from investment banks, hedge funds, insurance, and private equity activities, within a five-year transition period. This would ideally make the institutions more secure for depositors and mitigate the risk of another government bailout.