The Glass-Steagall Act of 1933 Enactment, Demise, Repeal
The Glass-Steagall Act of 1933 was passed by Congress as the Great Depression lengthened far beyond 1929 with no end in sight. The public through its elected representatives wanted some relief from the very unpleasant effects of that Great Depression. In addition, the public was perceived as desiring accountability for the occurrence of the Great Depression and preventives against its reoccurrence. There was an element of punishment to be meted out to whoever could be found as having caused the Great Depression.
The public was not in the mood for fine distinctions as to causation for the Great Depression and it was well known that the banking system was in a mess. Forty percent, or 11,000 banks, had failed or had been forced to merge (Understanding, par. 2). Some governors had closed banks in their states and President Roosevelt had, at one point, closed all US banks. There was a rampant anti-bank sentiment in the United States. Therefore, most probably, it was felt, the bankers had some role that they could have played in making the Depression great. So something was needed to get confidence back for the US banking system. In the Senate, Senator Carter Glass, a fiscal conservative from Virginia, and Representative Henry Steagall from Alabama in the House put forward a measure that passed with little debate. What debate there was dealt mostly with the unheard of idea of insuring bank deposits (Henriques 8). This provision of the Act became the now familiar Federal Deposit Insurance Corporation.
The provisions of the Act that were put in place to separate bankers and brokerage houses did not then merit much discussion. The separation of bankers and brokers was then seen as a financial corrective and a social punishment for the then easily seen evils of the banking system. Once the Great Depression was ended with an economic recovery and once the causes of the Great Depression could be studied; the Act was then found by bankers and others to be excessive in the limitations it imposed on financial dealings.
With the Glass-Steagall Act, banks had one year to decide if they wanted to become businesses that could handle deposits and administer savings accounts or if they wanted to become banks specializing in investments (Henriques 8). The latter was seen as the less secure business since it involved new securities from corporations for sale to the general investor. If they were to become ordinary commercial banks they could still involve themselves in the securities markets but only so that ten percent or less of their business was derived from the securities (Henriques 8). This ten percent restriction did not begin to provide enough income so most commercial banks quit Wall Street.
This ten percent restriction was a blanket prohibition but the details of the Act did nothing further to enhance banking operations. Section 16 of the Act did not allow for Federal Reserve member banks to obtain securities for their own use (Understanding, par. 9). Commercial banks could mostly deal in securities only directly through customer accounts. Both Sections 16 and 21 forbad underwriting activities unless for US government, state governments, and some higher education construction projects (Understanding, par. 9). Section 32 did not allow interlocking board of directors nor any kind of intimate association between employees of banks and Wall Street (Understanding, par. 12). There were to arise no conflicts of interest. Also, non-FDIC and savings and loans could do what the commercial banks could not do, according to Sections 20 and 32 of the Act. An unfair advantage was thus perpetrated.
Calls for repeal of the Act were soon forthcoming. Even Senator Glass called for repeal of the Act two years after its passage (Understanding, par. 4). The separation of commercial banking from investment banking had become unique to the US and to Japan (Understanding, par. 7). The Japanese had the separation and restrictions imposed on them since they were one of the losers in World War Two and because the Americans administered Japan for some years after the conclusion of World War Two. Both the Americans and Japanese banking interests suffered because other international banking operations were much freer of such regulation.
Though the Act was still on the books for many forthcoming decades, it was not being enforced or it was blurred by court decisions. The U. S. Supreme Court in 1971 noted that Sections 16 and 21 were in place to prevent commercial banks from engaging in activities that could involve something like mutual funds (Understanding, par. 10). This ruling was in response to a Citibank action in 1970. This court ruling was seen as a strict opinion of the Act’s provisions as to prohibitions. The Court placed itself in the position of doing what it thought was good for the banks. The banks were seen as harming themselves and allowing the public to be threatened financially through banking practices that were neither safe nor sensible. The banks could perhaps engage in speculation to too great an extent. Their assets could be invested, large risks could be engendered on unsound loans with the prospect of customers purchasing stock in firms that the banks already had a financial stake.
Prior to the 1971 ruling, banks had begun to approach Congress for repeal of the Glass-Steagall Act. The banks in the early 1960s wanted into the municipal bond market. To that end they sponsored major lobbying efforts to secure the end to the Glass-Steagall Act. They were not successful. But in the 1970s, without a court ruling, some brokers began to offer interest on money market accounts. These same brokers also offered check writing. These measures blurred the separation of function that the Act had endorsed during the Great Depression.
Further blurring occurred in 1986 when the Federal Reserve Board said that Section 20 of the Act could allow for commercial banks to deal in investment banking (Long Demise, par. 7). The Board thought that since the Act specifies that commercial banks cannot be occupied in a big way with investment banking then at least they could do so in a small way. So the Board declared that up to five per cent of gross revenues for a commercial bank engaging in investment bank business was acceptable. Specifically, the Federal Reserve Board allowed Bankers Trust to do some investment transactions.
The Federal Reserve Board and Bankers Trust were at it again in 1987. This time the Board’s favoritism extended to Citicorp and to J.P. Morgan, among others. Commercial banks could have dealings with municipal revenue bonds and securities if supported by mortgages (Long Demise, par. 8). It was thought that this relaxing the restrictions of Glass-Steagall could be permitted because since 1933 the Security and Exchange Commission had emerged as an effective regulator. Then too it was felt that investors were more savvy than in the 1930s and less prone to enter into or maintain risky financial adventures. Lastly, better agencies for rating the transactions were now in place.
But the Chairman of the Federal Reserve Board, Paul Volcker, did not agree with these reasons given for the relaxation of some of the provisions of the Act. He argued that the banks would make bad loans, that is, riskier loans in order to gain investments. He agreed that these new approaches erred on the side of risk as against the assurance of safe deposits. Further action by the Federal Reserve Board in 1987 included allowing Chase Manhattan to get into the investments business. At the same time the Board indicated that it would in the future raise the five percent gross revenues limit for commercial banks to ten percent. This was being done in the name of better competition among financial institutions and more efficiency in banking operations.
Mr. Volcker would have little more to say on the matter as Chairman of the Federal Reserve Board since 1987 also marked the end of his tenure in that position. Alan Greenspan became the head of the Board in August of 1987. He had long been an advocate of banking deregulation. As a former director of J.P. Morgan, he had wanted the deregulation in order so that banks, American banks, would not be at such a disadvantage when they went up against international bankers on the world scene.
The Federal Reserve Board dropped the other shoe in 1989 since it then did raise the limit for the allowed amount of investment activity by commercial banks to the aforementioned ten per cent (Long Demise, par. 11). The previous Big Four of the anti-Glass-Steagall faction which were Bankers Trust, J.P.Morgan, Citicorp, and Chase Manhattan, successfully lobbied to have their operations extended into debt and equity securities. This extension of permitted activity for commercial banks in general was a big increase in business for them.
Against this backdrop of Federal Reserve Board largesse, Congressional measures to repeal Glass-Steagall were put forward only to be beaten back on more than one occasion. The Senate was agreeable to loosening Glass-Steagall in 1984 and in 1988, but the House would not go along with such measures. In 1991 both the Congressional banking committees agreed to repeal the Act but the measure died on the House floor. Again, in 1995, the repeal of Glass-Steagall was a done deal in separate committee votes for the Senate and the House but no agreement was reached by joint committee. The major backers of repeal were the large banking interests, some of which have been named in the above, while supporters of Glass-Steagall were the smaller banking operations, and some insurance companies. Even within the ranks of those seeking repeal there was dissension since, though repeal was agreed upon, it was not agreed who among the supporters would get the larger slices of the pie. Supporters and opposers also battled over what agency should regulate banking. Each group had its pet reasons why it should be the Treasury Department or the Comptroller of the Currency or the Federal Reserve Board.
Despite the lack of Congressional action, Glass-Steagall was going down the tubes in any event due to decisions reached and enacted by the Federal Reserve Board. In 1996 the Board decided to up the ante on what percentage of gross revenues could be derived from investment dealings by commercial banks. The old limit of ten percent was to be superseded by an increase to twenty-five percent (Long Demise, par. 15). For all intents and purposes Glass-Steagall was dead. The loophole had become too big. Almost any commercial bank could carry on a significant investment business and not exceed the twenty-five percent limit. If Glass-Steagall had any room left to squirm, that ended in 1997 when the Federal Reserve Board said banks doing investment banking were doing fine so then banks could buy investment firms without practical restrictions (Long Demise, par.17). Before 1997 was done Bankers Trust bought Alex Brown and Company, an investment bank. Earlier in 1997 Travelers insurance company nearly merged with J. P. Morgan. Not to be outdone, J.P. Morgan merged with Chemical Bank. Meanwhile Travelers got it done with the acquisition of the Salomon Brothers investment bank. And then Salomon Brothers merged with Smith Barney, also owned by Travelers.
In 1998 the ghost of Glass-Steagall saw Travelers merge with Citicorp. This merger created the biggest financial services company in the world. It was also history’s largest corporate merger (Long Demise, par. 21). The sum of seventy billion dollars was put up in order to accomplish the merger. It is to be noted that this merger combined all the perceived evils that Glass-Steagall had addressed long ago in 1933. In this mix were commercial banking, insurance dealings, and investment banking. Glass-Steagall was not being openly flaunted. The merger moguls had checked with Mr. Greenspan of the Federal Reserve Board to get its blessing before proceeding. The merger was tailored along the lines of exceptions and lapses in Glass-Steagall that the Board had already gone along with earlier in the 1990’s and in the 1980’s. It was agreed that Travelers had two years to get Congress to repeal Glass-Steagall (Long Demise, par. 24). The merger gave lip service to being in compliance with Glass-Steagall, not the 1933 version of course, but to be in conformity with whatever remnants still remained of the Act.
Of course Travelers and others started up an intense lobbying effort to get Glass-Steagall out of the way and to push for new legislation that was to be called the Financial Services Modernization Act of 1999. All this merger effort could hardly really be put back in the bottle or kept in its box. The pitch was to modernize the Glass-Steagall Act with everyone portraying the Act as a going concern. The Republicans in general supported repeal of the Act while Democrats could be worked with if newer Democrats did not enter Congress after elections in the fall of 1999. But the huge financial forces at work in support for repeal could only get House approval by one vote and a Senate Banking Committee’s approval.
Certainly enough money could be made available to supporters of repeal. Those Congressional members on banking committees and in other finance jurisdictions could stand to benefit the most. About two hundred million dollars went into lobbying for repeal of Glass-Steagall and about one hundred and fifty million dollars found its way into campaign war chests (Long Demise, par. 30).
In 1999 the demise of the Glass-Steagall was made official. It was replaced by the Gramm-Leach-Bliley Act (Kitch 54). Supporters said the new Act was long overdue. They said pushing the panic button in the Depression era had given us Glass-Steagall. Now with such an outmoded Act out of the way, true financial excellence could be achieved. President Clinton was approached in the final hours of a deadlocked Congress so that the over the top push could be applied for repeal.
The firewall that had initially been in place to separate commercial banking from investment banking was now officially gone. The old protection from risk of loss for customers that had funds in banks that held deposits and invested too was no more. Charges of conflict of interest were going to be hard to avoid. The bigger your financial firm then the tougher for the smaller firms to compete. Repeal of the Act put a premium on bigger is better. It may not be better but it is there and must be dealt with. A concentration of financial power was at the very least gaining de facto support.
These concerns are only naysaying for the enthusiasts of the new financial order that emerged from the formal repeal of the Glass-Steagall Act. The repeal would allow for diversification of the banking industry so that customer risk could be reduced to acceptable levels. A full plate of financial services could be offered. At last, American banks could deal on a more equal footing with foreign financial houses that had for a long time blended commercial banking and investment banking. Previously, registration of an offering in the United States had been required though not required by foreigners in their home operations. So international financial deals by American entities could not be consummated until the American registration procedures had been complied with.
No longer did firms need to show that many completed deals or transactions in the works were not in violations of the old Glass-Steagall Act. The costly paperwork and legal assistance and meetings with regulators could be dispensed with. Other costs that the Act engendered for the financial firms had arisen from the need to be cautious about registering stocks with the SEC as opposed to seeking an exemption. No matter the size of the transaction, the financial firm was subject to the same internal debate as regards registration. The same voluminous procedures were required for small transactions as well those for the bigger transactions. The exemption sought was fulfilled if the investor had a net worth beyond one million dollars (Kitch 55). But not only businesses but private individuals with net worth more than the one million increased greatly. No more large penalties could be exacted for breaking the law which involved buyers of securities getting their money back or keeping them if they went up in value or, again, getting their money back should the securities lose value.
Also losing value were previous studies that showed a lack of separation of commercial and investments banks to be an inherently risky proposition. It had been found that no actual increased risk occurs for the depositors. Other concerns about required securities registration became moot as other studies all agreed that the registration did more harm than good.
Still other studies appear to document that Gramm-Leach-Bliley isn’t all that great an idea. Citigroup, J.P. Morgan, and others got themselves into a fix with their lending to Enron and Worldcom. Bad loans made to secure further business and increase profit harks back to the 1930s. But bad loans occur now and in the 1930s and at various times in between. Banks make the loan to secure access to a bigger account, to obtain fees for advising or handling transactions, or to get a lucrative client on board. Banks always seem to carry the ability to not make prudent loans. So arguments for some reduction in the possibility of bad banks getting out of control by reducing their temptation to do so seem to some to again be a good idea. The bankers might need help in saving themselves from themselves.
Henriques, Diana B. “Shaping a Colossus: The Law; A Challenge to the 1930’s Division of Financial Power.” The New York Times 7 April 1998. D8.
Kitch, Edmund W. “Readying for More Reform.” Regulation 25 (2002): 54-57.
The Long Demise of Glass-Steagall. 8 May 2003. PBS Frontline (WGBH). 15 Jan. 2006.
Understanding How Glass-Steagall Act Impacts Investment Banking and the Role of Commercial Banks. 12 April 1998. 14 Jan. 2006. <http://www.cftech.com/BrainBank/SPECIALREPORTS/GlassSteagall.html>