Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Glass-Steagall Act

What it is:

The Glass-Steagall Act was passed by Congress in 1933. It prohibited commercial banks from conducting brokerage or investment banking activities. The act was largely a product of the Great Depression, during which one of every five banks failed. In 1999, Congress repealed the act, replacing it with the Gramm-Leach-Bliley Act.

The Act is named after former Treasury secretary Senator Carter Glass (D-VA), who also was a founder of the U.S. Federal Reserve System, and Representative Henry Bascom Steagall (D-AL), who was the chairman of the House Banking and Currency Committee. 

An extension of the act -- the Bank Holding Company Act of 1956 -- further delineated what types of business banks could invest it by restricting them from underwriting insurance policies (selling insurance and insurance products was still OK) and restricted banks from buying other banks in other states.

How it works (Example):

The main idea behind the Glass-Steagall Act was to create a firewall between commercial and investment banking activities. Upon the passage of the act, banks had to decide whether they would become commercial lenders or investment banks. The act also established the Federal Depository Insurance Corporation (FDIC), which insures most bank deposits up to $100,000.

The $70 billion merger of Travelers Insurance (which owned Salomon Smith Barney) and Citicorp (which owned Citibank) in 1998 was a major step in the death of the Glass-Steagall Act. Citigroup would have had to divest the Travelers Insurance business within two to five years of the merger in order to comply with the act, but intense interest and lobbying regarding repealing the Glass-Steagall Act ensued immediately after the merger's announcement, leading to the repeal of the act in late 1999.

Why it Matters:

The Glass-Steagall Act's primary purpose was to protect bank depositors from the risks banks were taking when conducting brokerage and investment banking activities. The onus was the 1929 stock market crash, which devastated many banks that conducted failed underwriting deals or were unsuccessfully trading stocks for themselves and their depositors. In many cases, banks were also loaning money to certain companies and then encouraging its brokerage clients to invest in the stocks of those borrowers. 

The Glass-Steagall Act was very controversial. It sparked conversation about how much regulation was really necessary in the banking industry and whether those regulations stymied economic growth arbitrarily. The repeal of the act was just as controversial and was a long time coming after decades of gradual erosion via reinterpretations by the Federal Reserve and Congressional negotiations.

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