The Glass Steagall Act
Executive Summary
- This was part of the Banking Act of 1933 that placed a separation between investment banking and commercial banking.
Introduction
The official name of the act was The United States Banking Act of 1933. This made banks choose whether they would be a commercial bank or an investment bank. The result is described in the following quotation.
The long-lasting and comprehensive reforms of the era included deposit insurance, a continuation of unit banking, and federal laws on activity restrictions. These rules imposed a separation of traditional banking activities, such as lending and deposit-taking, from commercial activities, such as securities underwriting and brokering. The Glass-Steagall Act, the pillar of the New Deal banking reforms, thus entrenched the doctrine of “separation of banking and commerce” in U.S. banking regulation.82 The act also contained interest rate limits—the amount a bank could offer for deposits—intended to deter competition among banks. Reduced competition, it was believed, would lead to a more dispersed banking sector and more credit availability.These reforms were a response to the recent banking crisis, but they also revealed a Jeffersonian and Brandeisian disdain for concentrated bank power. Although they were intended to make banks safer, they were also meant to limit banks’ market reach and power.
Source: How the Other Half Banks
https://www.amazon.com/How-Other-Half-Banks-Exploitation/dp/0674286065
Neoliberal Repeal of Glass Steagall
This act was repealed under Bill Clinton, massively increasing the risk in private banking. After the 2008 crisis, the US now has banks that are both commercial and investment banks. They receive depository insurance while gambling as investment banks. The reality in the US is that banks now not only are unrestricted by the investment banks / commercial bank divide. They now own major areas of industry as is explained in the following quotation.
“Banks in America were never meant to own industries. This principle has been part of our culture practically from the beginning of our history. The original restrictions on banks getting involved with commerce were rooted in the classically American fear of overweening government power – citizens in the early 1800s were concerned about the potential for monopolistic abuses posed by state-sponsored banks. Banks, however, were never really regulated under those laws. Only the Great Depression and years of brutal legislative trench warfare finally brought them to heel under the same kinds of anti-trust concepts that stopped the robber barons, through acts like Glass-Steagall and the Bank Holding Company Act of 1956. Then, with a few throwaway lines in a 1999 law that nobody ever heard of until now, that whole struggle went up in smoke, and here we are, in Hobbes’ jungle, waiting for the next fully legal catastrophe to unfold.” – Matt Taibbi
Source: Rolling Stone
Dilution of Glass Steagall
There was dilution of Glass Steagall from the beginning as is explained in the following quotation.
As the “Thou Shalt Nots” of Glass-Steagall were replaced with a more fluid system that depended on firms’ internal models of risk weighing, risks also increased. For several decades, banks became very profitable, and the financial world grew exponentially as barriers disappeared. Even so, bank failures started to occur much more often during the deregulatory era. Empirical researchers have found that “the probability of a banking crisis occurring was similar during 1880–1913 and 1973–97 … and essentially zero during 1945–71.” The deregulatory era culminated in the financial crisis of 2008, proving most of the deregulatory era’s assumptions wrong. It was inevitable that in an era of deregulated banks, large failures would occur. What was surprising was that the market rules would only be applied when banks were making profits and not when they ultimately failed. Instead of allowing the market to enforce its discipline and allow banks to fail, as the repudiation of the social contract dictated, the government stepped in and bailed out the banking industry. As the 2008 financial crisis deepened, policymakers faced a choice: they could let free markets take their course and allow a wide-scale failure of the financial sector (which was what was envisioned by the preceding era of deregulation), or they could intervene in the private markets. They chose to intervene in a way that revealed “the lasting influence and power of the Wall Street ideology—that big, private, lightly regulated financial institutions are good for America.” In other words, instead of using the crisis to effect real reform in banking like Roosevelt did, these policymakers focused myopically on maintaining bank profitability without requiring anything in return—“the government bent over backward to make the deal attractive for the banks, charging below-market interest and eschewing any significant ownership—so shareholders, not taxpayers, would benefit when the banks recovered.” Simon Johnson and James Kwak articulated the incongruity of it all: “Never before had so much taxpayer money been dedicated to save an industry from the consequences of its own mistakes. In the ultimate irony, it went to an industry that had insisted for decades that it had no use for the government and would be better off regulating itself—and it was overseen by a group of policymakers who agreed that governments should play little role in the financial sector.”
Source: How the Other Half Banks