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Glass Steagall Act – Definition

Glass-Steagall Act Definition

The Glass-Steagall Act of 1933 describes the provisions of the USA Banking Act aimed at separation of commercial and investment banking. It prohibited the commercial banks from using depositor’s funds for investments which were risky. The act takes it name from its sponsors 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 on June 16, 1933, as a reform as response to the 1929 stock market crash and commercial bank failure also known as Great Depression.

A Little More on the Glass-Steavall Act

There were two primary objectives of the Glass-Steagall Act. The first objective was to restore public’s confidence in the U.S. banking system which was impacted by the banking failure of the late 1920s. The second objective was to separate and prohibit commercial banks from involvment in investment banking, as it was believed to have been primarily responsible for the 1929 market crash. The belief was that the crash was due to a conflict of interest between duties to clients and self interest when commercial banks engaged in investment banking.

Glass-Steagall lost its effectiveness in subsequent decades and many commentators argued Glass–Steagall was already “dead”. In 1998, Citibank affiliated with one of the largest US securities firms, Salomon Smith Barney, which was permitted under the Federal Reserve Board’s interpretation of the Glass–Steagall Act. On 12 November 1999, President Bill Clinton publicly declared the act to be no longer appropriate. Congress had passed the Gramm-Leach-Bliley Act along party lines, led by a republican vote in the Senate. It was believed by some economists that this contributed to the 2008 global credit crisis, where commercial banks globally had losses worth billions of dollars due to their involvement in investment banking. The severity of the crisis forced top investment banks to convert into bank holding companies (example Goldman Sachs and Morgan Stanley) through the acquisition of some investment banks by commercial banks (example Merrill Lynch was acquired by Bank of America). These developments indicated the final demise of the Glass-Steagall Act.

Apart from separating commercial banks and investment banking, the Glass-Steagall Act also created the Federal Deposit Insurance Corporation (FDIC), which assured bank deposits up to a specified limit. The act also created the Federal Open Market Committee (FOMC) and regulation Q, which prohibited banks from paying interest on checking accounts and allowed the Federal Reserve Bank to set ceilings on interest rates on other deposit products.

Potential Re-Instatement of the Glass-Steagall Act

Many believe a reinstatement of Glass-Steagall would do better to protect bank depositors. Reinstatement would certainly lead to large scale reorganization in the banking industry. There have been some unsuccessful attempts to reinstate the act. During the 2016 presidential campaign, Donald Trump implied a potential reinstatement of the Glass-Steagall Act. After his formation of the government in the 2017 elections, the head of the National Economic Council, Gary Cohn, revived talks of restoring the act to break up the big banks. The senators in support of this ideology such as John McCain and Elizabeth Warren were prompted to initiate a draft of the act for 21st century to introduce separation of traditional banks from investment banks, hedge funds, insurance, and other private equity activities. This would decrease the risk of another government bailout.

References for Glass – Steagall Act

Academic Research on the Glass-Steagall Act

·       Is the GlassSteagall Act justified? A study of the US experience with universal banking before 1933, Kroszner, R. S., & Rajan, R. G. (1994). The American Economic Review, 810-832. An analysis on the argument for the separation of commercial and investment banking.

·       The underwriting experience of commercial bank affiliates prior to the GlassSteagall Act: A reexamination of evidence for passage of the act, Ang, J. S., & Richardson, T. (1994). Journal of Banking & Finance, 18(2), 351-395. An examination of a major rationale for the passage of the Glass-Steagall Act.

Before the GlassSteagall Act: An analysis of the investment banking activities of national banks, White, E. N. (1986). Explorations in Economic History, 23(1), 33. This paper examines the relationship between banks divergent strategies and contingencies.

·       Organization structure and credibility: Evidence from commercial bank securities activities before the GlassSteagall Act, Kroszner, R. S., & Rajan, R. G. (1997). Journal of Monetary Economics, 39(3), 475-516. We analyze the two ways in which US commercial banks organized their investment banking operations before the 1933 Glass-Steagall Act.

 

·       The repeal of the GlassSteagall Act and the current financial crisis, Crawford, C. (2011). Journal of Business & Economics Research, 9(1), 127-134. This article connects the passage of he Glass-Steagall act to the underpinnings of the Great Depression.

·       The erosion of the GlassSteagall Act:: Winners and losers in the banking industry, Cyree, K. B. (2000). The erosion of the Glass–Steagall Act:: Winners and losers in the banking industry. Journal of Economics and Business, 52(4), 343-363. This paper analyzes stock price reaction to increased investment banking powers for commercial banks using Seemingly Unrelated Regressions.

·       Expansion of National Bank Powers: Regulatory and Judicial Precedent Under the National Bank Act, GlassSteagall Act, and Bank Holding Company Act, Dunn, J. D. (1982). Sw. LJ, 36, 765.

·       The Great Fall: The Consequences of Repealing the GlassSteagall Act, Brown Jr, J. R. (1995). The Great Fall: The Consequences of Repealing the Glass-Steagall Act. Stan. JL Bus. & Fin., 2, 129.

·       The GlassSteagall Act in historical perspective, Neal, L., & White, E. N. (2012). The Quarterly Review of Economics and Finance, 52(2), 104-113. This article takes a historical view of the Glass Steagal act. It specifically addresses the implementation of the Volker Rule.

·       Are universal banks better underwriters? Evidence from the last days of the GlassSteagall Act, Focarelli, D., Marques-Ibanez, D., & Pozzolo, A. (2011). A historical review of the 1933 Glass-Steagall Act.

·       American Banks or the GlassSteagall Act-Which Will Go First, Tavelman, F. M. (1992). Sw. UL Rev., 21, 1511.

·       Commercial Banks and the GlassSteagall Act: A Survey of New Products and Activities, Willin, J. K. (1987). Banking LJ, 104, 5.

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