Glass–Steagall Act

Glass–Steagall Act
Full title An act to provide for the safer and more effective use of the assets of banks, to regulate interbank control, to prevent the undue diversion of funds into speculative operations, and for other purposes.
Colloquial name(s) Banking Act of 1933
Glass–Steagall Act
Enacted by the 73rd United States Congress
Effective June 16, 1933
Citations
Public Law Pub.L. 73-66
Stat. 48 Stat. 162
Codification
Legislative history
Major amendments
Gramm–Leach–Bliley Act
Depository Institutions Deregulation and Monetary Control Act
Relevant Supreme Court cases
None

The Banking Act of 1933, Pub.L. 73-66, 48 Stat. 162, enacted June 16, 1933, was a law that established the Federal Deposit Insurance Corporation (FDIC) in the United States and introduced banking reforms, some of which were designed to control speculation.[1] It is most commonly known as the Glass–Steagall Act, after its legislative sponsors, Senator Carter Glass (DVa.) and Representative Henry B. Steagall (D–Ala.-3). Some provisions of the Act, such as Regulation Q, which allowed the Federal Reserve to regulate interest rates in savings accounts, were repealed by the Depository Institutions Deregulation and Monetary Control Act of 1980. Provisions that prohibit a bank holding company from owning other financial companies were repealed on November 12, 1999, by the Gramm–Leach–Bliley Act, named after its co-sponsors Phil Gramm (R, Texas), Rep. Jim Leach (R, Iowa), and Rep. Thomas J. Bliley, Jr. (R, Virginia).[2][3]

The repeal of provisions of the Glass–Steagall Act by the Gramm–Leach–Bliley Act in 1999 effectively removed the separation that previously existed between investment banking which issued securities and commercial banks which accepted deposits. The deregulation also removed conflict of interest prohibitions between investment bankers serving as officers of commercial banks.[4][5][6][7][8][9]

Contents

Background

Two separate United States laws are known as the Glass–Steagall Act. Both bills were sponsored by Democratic Senator Carter Glass of Lynchburg, Virginia, a former Secretary of the Treasury, and Democratic Congressman Henry B. Steagall of Alabama, Chairman of the House Committee on Banking and Currency.

The first Glass-Steagall Act of 1932 was enacted in an effort to stop deflation, and expanded the Federal Reserve's ability to offer rediscounts on more types of assets, such as government bonds as well as commercial paper.[10] The second Glass–Steagall Act (the Banking Act of 1933) was a reaction to the collapse of a large portion of the American commercial banking system in early 1933. Literature in economics usually refers to this latter act simply as the Glass–Steagall Act, since it had a stronger impact on US banking regulation.[11]

Overview

The act introduced the separation of the bank types according to their business (commercial and investment banking), and it founded the Federal Deposit Insurance Corporation (FDIC) for insuring bank deposits. The FDIC law was an amendment to the Federal Reserve Act, which was later withdrawn as part of this Glass–Steagall Act and Federal Reserve Act to become the Federal Deposit Insurance Act by decree in the Federal Deposit Insurance Act of 1950.

"Rediscounting" is a way of providing financing to a bank or other financial institution. Especially in the 19th century and early 20th century, banks made loans to their customers by "discounting" their customers' notes. Such a note is a paper document, in a specified form, in which the borrower promises to pay a certain amount at a specified, future date. For example, assume a customer wants to borrow $1000 for one year. In exchange for giving him $1000 today, the bank might ask him to sign a note promising to pay $1100 one year from now. The bank is "discounting" the note by giving the customer less than the note's $1100 face value. The extra $100 is the bank's compensation for providing the $1000 to the customer before the note matures. The Federal Reserve System could provide financing to the bank by "rediscounting" this note, for example, by giving the bank $1050 in exchange for the note.

While most economic historians attribute the U.S. economic collapse to the economic problems which followed the Stock Market Crash of 1929, Austrian School economists attribute the collapse to gold-backed currency withdrawals by foreigners who had lost confidence in the dollar and by domestic depositors who feared the United States would go off the gold standard,[12] which it did when Roosevelt signed Executive Order 6102, the Gold Confiscation Act of April 5, 1933.[13]

According to a summary by the Congressional Research Service of the Library of Congress:

In the nineteenth and early 20th centuries, bankers and brokers were sometimes indistinguishable. Then, in the Great Depression after 1929, Congress examined the mixing of the "commercial" and "investment" banking industries that occurred in the 1920s. Hearings revealed conflicts of interest and fraud in some banking institutions' securities activities. A formidable barrier to the mixing of these activities was then set up by the Glass–Steagall Act.[14]

Repeal

See also Depository Institutions Deregulation and Monetary Control Act of 1980, the Garn–St. Germain Depository Institutions Act of 1982, and the Gramm–Leach–Bliley Act of 1999.

The bill that ultimately "repealed" the Act was brought up in the Senate by Phil Gramm (R-Texas) and in the House of Representatives by Jim Leach (R-Iowa) in 1999. The bills were passed by a Republican majority, basically following party lines by a 54–44 vote in the Senate[15] and by a bi-partisan 343–86 vote in the House of Representatives.[16] After passing both the Senate and House the bill was moved to a conference committee to work out the differences between the Senate and House versions. The final bill resolving the differences was passed in the Senate 90–8 (one not voting) and in the House: 362–57 (15 not voting). The legislation was signed into law by President Bill Clinton on November 12, 1999.[17]

In reality, the repeal involved only one provision of the Act, the one preventing the same holding company from controlling both a commercial bank and an investment bank."[18] Proponents argue that repealing this provision had little impact on the financial system and even helped restore stability during the financial crisis.[18][19][20] Ten years after its repeal, detractors condemn Glass-Stegall's repeal for reestablishing conflict of interest within the financial industry and fostering "too big to fail" institutions that led to the housing market collapse and its associated financial crisis.[21]

The banking industry had been seeking the repeal of Glass–Steagall since at least the 1980s. In 1987, the Congressional Research Service prepared a report which explored the cases for and against preserving the Glass–Steagall act.[14]

The argument for preserving Glass–Steagall (as written in 1987):

  1. Conflicts of interest characterize the granting of credit (that is to say, lending) and the use of credit (that is to say, investing) by the same entity, which led to abuses that originally produced the Act.
  2. Depository institutions possess enormous financial power, by virtue of their control of other people's money; its extent must be limited to ensure soundness and competition in the market for funds, whether loans or investments.
  3. Securities activities can be risky, leading to enormous losses. Such losses could threaten the integrity of deposits. In turn, the Government insures deposits and could be required to pay large sums if depository institutions were to collapse as the result of securities losses.
  4. Depository institutions are supposed to be managed to limit risk. Their managers thus may not be conditioned to operate prudently in more speculative securities businesses. An example is the crash of real estate investment trusts sponsored by bank holding companies (in the 1970s and 1980s).

The argument against preserving the Act (as written in 1987):

  1. Depository institutions will now operate in "deregulated" financial markets in which distinctions between loans, securities, and deposits are not well drawn. They are losing market shares to securities firms that are not so strictly regulated, and to foreign financial institutions operating without much restriction from the Act.
  2. Conflicts of interest can be prevented by enforcing legislation against them, and by separating the lending and credit functions through forming distinctly separate subsidiaries of financial firms.
  3. The securities activities that depository institutions are seeking are both low-risk by their very nature and would reduce the total risk of organizations offering them – by diversification.
  4. In much of the rest of the world, depository institutions operate simultaneously and successfully in both banking and securities markets. Lessons learned from their experience can be applied to our national financial structure and regulation.[14]

Events following repeal

The repeal enabled commercial lenders such as Citigroup, which was in 1999 the largest U.S. bank by assets, to underwrite and trade instruments such as mortgage-backed securities and collateralized debt obligations and establish so-called structured investment vehicles, or SIVs, that bought those securities.[22] Elizabeth Warren,[23] author and one of the five outside experts who constitute the Congressional Oversight Panel of the Troubled Asset Relief Program, has said the repeal of this act contributed to the Global financial crisis of 2008–2009.[24][25] Others have debated what role the repeal may have played in the financial crisis.[8][26][27][28][29]

The year before the repeal, sub-prime loans were just five percent of all mortgage lending. By the time the credit crisis peaked in 2008, they were approaching 30 percent. This correlation is not necessarily an indication of causation, however, since there are several other significant events that have impacted the sub-prime market during that time. These include the adoption of mark-to-market accounting, implementation of the Basel Accords and the rise of adjustable rate mortgages.[30]

Proposed re-enactment

In mid-December 2009, Republican Senator John McCain of Arizona and Democratic Senator Maria Cantwell of Washington State jointly proposed re-enacting the Glass–Steagall Act, to re-impose the separation of commercial and investment banking that had been in effect from the original Act in 1933, to the time of its initial repeal in 1999.[31] Legislation to re-enact parts of Glass–Steagall was also introduced into the House of Representatives. Banks such as Bank of America have strongly opposed the proposed re-enactment.[32]

On January 21, 2010, President Barack Obama proposed bank regulations similar to some parts of Glass–Steagall in limiting the trading and investment capabilities of certain banks. The proposal was dubbed "The Volcker Rule",[33] for Paul Volcker, who has been an outspoken advocate for the reimplementation of some aspects of Glass–Steagall[34] and who appeared with Obama at the press conference in support of the proposed regulations. However, in May 2010, Volcker, in an interview with BBC Business Editor Robert Peston, said he was not advocating a return to Glass–Steagall or a complete separation between investment and commercial banking.[35] In a May 2010 interview with Alternet, economist Nouriel Roubini described the "Volcker Rule" as insufficient and "essentially Glass–Steagall-Lite," allowing conflicts of interest to remain and for financial entities to continue to be "too big to fail", a model he described as a disaster, and stated, "We need to go all the way and implement the kind of restrictions between commercial banking and investment banking that existed under Glass–Steagall."[36]

In 2011 Representative Marcy Kaptur (D-OH) introduced H.R. 1489,[37] the "Return to Prudent Banking Act of 2011", to repeal certain provisions of the Gramm–Leach–Bliley Act and revive the separation between commercial banking and the securities business, in the manner provided in the Banking Act of 1933, the so-called "Glass–Steagall Act".

In Mainland Europe, notably in France, Germany, and Italy, an increasing number of think-tanks are calling for the adoption of stricter bank regulation through new national and EU-wide legislations based on the Glass–Steagall Act.

Glass-Steagall and the Dodd–Frank Act

The Dodd–Frank Wall Street Reform and Consumer Protection Act (Pub.L. 111-203, H.R. 4173) is a federal statute in the United States that was signed into law by President Barack Obama on July 21, 2010. The Act is a product of the financial regulatory reform agenda of the 111th United States Congress and the Obama administration.

Journalist Gretchen Morgenson argues that the Dodd–Frank Act is not strong enough, arguing that it fails to protect consumers adequately, and, more importantly, fails to cut big and interconnected financial entities down to size.[38]

Some think-tanks such as the World Pensions Council (WPC) have argued that the dismantlement of the Glass–Steagall Act was only the symptom of a much deeper problem: the emergence of a new economic paradigm associating the worst interpretations of Keynesian monetary stimulus with unbridled deregulation that came to define the Clinton and Bush eras (1993–2009).[39] In that perspective, they view the Dodd–Frank Act as insufficient, lacking the "broad provisions necessary to restore financial orthodoxy and minimize conflicts of interests".[40]

See also

References

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  12. ^ http://mises.org/rothbard/agd/chapter12.asp
  13. ^ Gold Confiscation Act, http://www.the-privateer.com/1933-gold-confiscation.html 
  14. ^ a b c http://digital.library.unt.edu/govdocs/crs/permalink/meta-crs-9065:1
  15. ^ On Passage of the Bill (S.900 as amended ), http://www.senate.gov/legislative/LIS/roll_call_lists/roll_call_vote_cfm.cfm?congress=106&session=1&vote=00105, retrieved 2008-06-19 
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  32. ^ Eckblad, Marshall (January 4, 2010), "Bank of America CEO Expects 'Long, Slow Recovery'", Wall Street Journal, http://online.wsj.com/article/SB10001424052748703580904574638414165296326.html 
  33. ^ Uchitelle, Louis (January 22, 2010), "Glass-Steagall vs. the Volcker Rule", The New York Times, http://economix.blogs.nytimes.com/2010/01/22/glass-steagall-vs-the-volcker-rule/, retrieved 2010-01-27 
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  36. ^ Carter, Zach (May 18, 2010), "How to Break Up the Banks, Stop Massive Bonuses, and Rein in Wall Street Greed", Alternet, http://www.alternet.org/news/146900/nouriel_roubini%3A_how_to_break_up_the_banks,_stop_massive_bonuses,_and_rein_in_wall_street_greed?page=entire, retrieved 2010-05-18 
  37. ^ Kaptur, Marcy. "Return to Prudent Banking Act of 2011". The Library of Congress-Thomas. http://thomas.loc.gov/home/gpoxmlc112/h1489_ih.xml. Retrieved 18 October 2011. 
  38. ^ Morgenson, Gretchen (June 25, 2010), "Strong Enough for Tough Stains?", New York times, http://www.nytimes.com/2010/06/27/business/27gret.html, retrieved 2010-06-25 
  39. ^ (English)"see Ionescu Romeo, "Romania and Greece: Together or Alone", AJBM Vol. 4 (19), p. 4197, December, 2010 [Quoting Q1 2010 article (in French) by M. Nicolas J. Firzli in Revue Analyse Financière"]. http://www.academicjournals.org/ajbm/PDF/pdf2010/29Dec/Romeo.pdf. Retrieved 29 March 2011. 
  40. ^ (French) M Nicolas Firzli, Orthodoxie financière et régulation bancaire: les leçons du Glass-Steagall Act (Bank Regulation and Financial Orthodoxy: the Lessons from the Glass-Steagall Act), http://www.canadianeuropean.com/yahoo_site_admin/assets/docs/Bank_Regulation_and_Financial_Orthodoxy__RAF__Jan_2010.784613.pdf, retrieved 2010-01-08 

Further reading

External links