What is the Glass Steagall Act?

Published by Thomas Herold in Banking, Laws & Regulations

'Glass Steagall Act' is explained in detail and with examples in the Banking edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Congress created and passed the Glass Steagall Act in 1933. This legislation arose because of the effects of the 1929 catastrophic stock market crash. Two congressmen came up with this solution in the Great Depression when many banks were failing. The law made separate all activities which involved commercial banking and investment banking.

Commercial banks had become heavily involved in the stock market. This activity received much of the blame for the stock market and financial crashes. Lawmakers felt that commercial banks had employed money from their depositors in speculation in the stock market.

The reasons this act came forcefully into law had to do with banks’ activities. Commercial banks had bought new and unproven stocks to sell to individual customers.  It was the greed of banks that led to the new legislation. The goals of banking were mired in conflict of interest. Banks would make loans to corporations in which they already had an investment. These loans were not issued based on good underwriting.

They would then push these investments to their clients. Their goal was to have their customers help support these companies. Such commercial speculation insured that when the companies failed, the banks and their customers all lost huge amounts of money. Finally banks began to collapse in the thousands as a result of this poor and unregulated activity.

The act actually came about because of Senator Carter Glass. Glass had served as Treasury secretary previously. He also founded the U.S. Federal Reserve System. The failing banks motivated him to act on a bill. He became the main driving force of this legislation. His partner on the project was Henry Bascom Stegall.

Stegall served as House Banking and Currency Committee chairman. At first he would not support the bill with Glass. They added an amendment to create insurance for bank deposits. This brought Congressman Steagall’s critical support of the act.

The effects of this Glass Steagall Act erected a variety of barriers in the banking industry. A new firewall of regulation arose between investment bank and commercial bank businesses. The two types of banks experienced unprecedented oversight and control over their activities. All banks received one year to choose a specialty in either investment banking or commercial banking.

Those that chose commercial banking were heavily limited in their investment banking activities. Income from securities could not exceed 10% of the commercial bank earnings. Commercial banks were permitted to underwrite bonds the government issued. The ultimate goal was to stop banks from committing their depositors’ funds to projects which were poorly underwritten and speculative.

Banks that were too big to fail at the time became significant targets for this act. JP Morgan and Company and rival financial empires were among these. Such outfits had to eliminate many services. This targeted a large and important part of their incomes.

Later on criticism of the Glass Steagall Act arose. This happened as different explanations became popular for the Great Depression. Many different individuals also saw that this act had created problems for financial services. They blamed the law for restricting financial firms to the point that they were not able to compete effectively.

Many opposed the act by the 1980s. Glass Steagall opposition grew into the 1990s. Congress finally repealed the act in 1999. The elimination of this act has been blamed for the Great Recession crisis that started in 2006.

Banks were again able to mix investment and lending activities. Close regulation of commercial banks had been largely eliminated. Because of this, banks again made many risky loans that were either liar loans or not properly documented for income.

Free Download (No Signup Required) - The 100 Most Important Financial Terms You Should Know!
This practical financial dictionary helps you understand and comprehend the 100 most important financial terms.

The term 'Glass Steagall Act' is included in the Banking edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.