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Glass-Steagall Act

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The Glass-Steagall Act, also known as the Banking Act of 1933 (48 Stat. 162), created the regulatory framework for banking following the depression-era collapse of much of the banking system. It established the Federal Deposit Insurance Corporation (FDIC) and included other banking reforms, and placed legal restrictions on combined banking and financial service firms.

The 1999 Gramm-Leach-Bliley Act repealed much of the Glass-Steagall Act and is credited with being a contributor to the 2008 financial collapse.[1]

Origins of the act

Between 1929 and 1933, more than 4,000 U.S. banks had closed permanently, saddling depositors with close to $400 million in losses. In 1930, the Bank of the United States failed, reportedly because of activities of its security affiliates that created artificial conditions in the market. In March 1933, all of the banks throughout the country were closed for a four-day period by President Roosevelt, and 4,000 banks closed permanently.[2]

One of the causes of the problems was banks using depositor's funds in sideline businesses such as underwriting. William Donaldson, a former chairman of the Securities and Exchange Commission, said in an interview: “If they were underwriting a stock offering and had trouble getting rid of the stuff, they would buy it with people’s deposits.”[3]

According to DEMOS: A Brief History of the Glass-Steagall Act[2], the Pecora Commission, a congressional investigation led by prosecutor Ferdinand Pecora unearthed massive evidence of recklessness, cronyism, and fraud both in the use of depositor funds and in the promotion of securities for sale to the public. A top executive of Chase National Bank (ancestor of today’s JPMorgan Chase) had enriched himself by short-selling his company’s shares during the stock market crash. National City Bank (now Citibank) had taken failed loans to Latin American governments, packaged them as securities, and unloaded them on unsuspecting investors. Banking and securities underwriting made for a poisonous combination, many people concluded.

To help restore public confidence that banks would follow reasonable banking practices, Congress passed the Glass-Steagall Act.[4]

Senator Carter Glass, a former Treasury secretary and the founder of the U.S. Federal Reserve System, was the primary force behind the Act. Representative Henry Bascom Steagall, chairman of the House Banking and Currency Committee agreed to support the act with Glass after an amendment was added permitting bank deposit insurance.[5]

Provisions of the act

The Glass-Steagall Act banks a year to decide whether to get out of the securities business and receive the benefits of deposit insurance and access to the low-interest credit of the Federal Reserve, or instead be investment banks and brokerage houses, and forego those privileges.[2]

The act gave tighter regulation of national banks to the Federal Reserve System; prohibited bank sales and underwriting of securities (with the exception of U.S. Treasury and federal agency securities); and created the Federal Deposit Insurance Corporation (FDIC), which insures bank deposits with a pool of money appropriated from banks.[4]

The Glass-Steagall Act consisted of four provisions to address the conflicts of interest that the Congress concluded had helped trigger the 1929 crash:[1]

  • Section 16 restricted commercial national banks from engaging in most investment banking activities;
  • Section 21 prohibited investment banks from engaging in any commercial banking activities;
  • Section 20 prohibited any Federal Reserve-member bank from affiliating with an investment bank or other company “engaged principally” in securities trading;
  • Section 32 prohibited individuals from serving simultaneously with a commercial bank and an investment bank as a director, officer, employee, or principal.

Effects of the act

The act set up regulations separating commercial and investment bank activities. By creating this barrier, the ACT was aiming to prevent the banks' use of deposits in the case of a failed underwriting job.

Bank Holding Company Act

In 1950 Congress passed the Bank Holding Company Act, which extended Glass-Steagall to create a wall between insurance activities and banking. Congress felt that the high risks in underwriting insurance were not good for banks.

Repeal of the act

According to DEMOS: A Brief History of the Glass-Steagall Act[2], in the spring of 1987, the Federal Reserve Board voted 3-2 to let banks engage in a range of securities underwriting activities. One of the dissenting votes was cast by Fed chairman Paul Volcker, who feared (among other things) that banks would again seek to profit from lucrative loan securitization opportunities.

But Volcker's successor, Alan Greenspan, believed that markets are self-correcting. During the presidency of George H.W. Bush, Greenspan and Treasury Secretary James Baker took steps that weakened Glass-Steagall by, for example, letting banks underwrite municipal bonds on the premise that they were safe by definition. In 1991, the administration called on Congress to repeal the law outright.

Citibank/Travelers merger

In 1998 Citibank merged with Travelers Group. The merger clearly violated the Bank Holding Company Act extension of Glass-Steagall, but Citibank was given a two-year forbearance that was based on an assumption that they would be able to force a change in the law.

Again, according to DEMOS: A Brief History of the Glass-Steagall Act[2], the final push took a year and a half, and entailed hundreds of millions of dollars in lobbying and campaign contributions. But on November 12, 1999, Clinton signed the Gramm-Leach-Bliley Act into law.7

The repeal

Important regulatory provisions of the Glass-Steagall Act were repealed by the Gramm-Leach-Bliley Act, also known as the Financial Services Modernization Act of 1999. Gramm-Leach-Bliley was enacted on November 12, 1999, repealing the legal restrictions on combining banking and financial service firms of the Glass-Steagall Act of 1933. Repealing Glass-Steagall allowed banking companies, securities companies and insurance companies to merge with each other, thus making the Citigroup/Traveler Group merger legal.

Top Citigroup officials were allowed to review and approve drafts of the legislation before it was formally introduced.[1] After resigning as Treasury Secretary and while secretly in negotiations to head Citigroup, Robert Rubin helped broker the final deal to pass the bill.[1]

Comments on the repeal

"Today Congress voted to update the rules that have governed financial services since the Great Depression and replace them with a system for the 21st century," said then-Treasury Secretary Lawrence Summers. "This historic legislation will better enable American companies to compete in the new economy."[6]

"I welcome this day as a day of success and triumph," said Sen. Christopher Dodd, (D-Conn.).[6]

"The concerns that we will have a meltdown like 1929 are dramatically overblown," said Sen. Bob Kerrey, (D-Neb.).[6]

"If we don't pass this bill, we could find London or Frankfurt or years down the road Shanghai becoming the financial capital of the world," said Sen. Chuck Schumer, D-N.Y. "There are many reasons for this bill, but first and foremost is to ensure that U.S. financial firms remain competitive."[6]

Apology for repeal

On November 6, 2009, John S. Reed, the former head of Citigroup who helped engineer the company's merger with Travelers Group, apologized and said banks that big should be divided into separate parts. “I’m sorry,” Reed, 70, said in an interview yesterday. “These are people I love and care about. You could imagine emotionally it’s not easy to see what’s happened.”[7]

Articles and resources

See also

References

  1. 1.0 1.1 1.2 1.3 Sold Out - How Wall Street and Washington Betrayed America , Consumer Education Foundation, March, 2009. Retrieved October 10, 2009.
  2. 2.0 2.1 2.2 2.3 2.4 James Lardner, A Brief History of the Glass-Steagall Act: A Background Paper, DEMOS, November 10, 2009
  3. Louis Uchitelle, Glass-Steagall vs. the Volcker Rule, Economix, New York Times, January 22, 2010
  4. 4.0 4.1 Glass-Steagall Act (1933), Times Topics, New York Times, undated.
  5. Reem Heakal, What Was The Glass-Steagall Act?, Investopedia, undated.
  6. 6.0 6.1 6.2 6.3 Sam Stein, Glass-Steagall Act: The Senators And Economists Who Got It Right, Huffington Post, May 11, 2009.
  7. Bob Ivry, Reed Says ‘I’m Sorry’ for Role in Creating Citigroup, Bloomberg, November 6, 2009

External resources

External articles

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