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Glass–Steagall legislation

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This article is about the 1933 Act establishing the FDIC. For the 1932 Act by the same sponsors, see Glass–Steagall Act of 1932.
Glass–Steagall legislation
Great Seal of the United States
Long titleBanking Act of 1933
Acronyms (colloquial)Glass–Steagall Act
Enacted bythe 73rd United States Congress
EffectiveJune 16, 1933
Citations
Public lawPub. L. 73-66
Statutes at Large48 Stat. 162 (1933)
Legislative history
Major amendments
American Homeownership and Economic Opportunity Act, Gramm–Leach–Bliley Act, Depository Institutions Deregulation and Monetary Control Act
Wikisource has original text related to this article:

The Banking Act of 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, Carter Glass and Henry B. Steagall.

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the Act, such as Regulation Q, which allowed the Federal Reserve to regulate interest rates in savings accounts, were repealed by the Depository Institutions Deregulation and Monetary Control Act of 1980. Provisions that prohibit a bank holding company from owning other financial companies were repealed on November 12, 1999, by the Gramm–Leach–Bliley Act. [2][3]

The repeal of the Glass–Steagall Act of 1933 effectively removed the separation that previously existed between Wall Street investment banks and depository banks. Many claim this repeal directly contributed to the severity of the Financial crisis of 2007–2010.[4]

Overview

Sen. Carter Glass (D—Va.) and Rep. Henry B. Steagall (D—Ala.-3), the co-sponsors of the Glass–Steagall Act.

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.[5] 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. It introduced the separation of bank types according to their business (commercial and investment banking), and it founded the Federal Deposit Insurance Corporation for insuring bank deposits. 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.[6]

"Rediscounting" is a way of providing financing to a bank or other financial institution. Especially in the 1800s and early 1900s, 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 that 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.

Although Republican President Herbert Hoover lost reelection in November 1932 to Democratic Governor Franklin D. Roosevelt of New York, the administration did not change hands until March 1933. The lame-duck Hoover Administration and the incoming Roosevelt Administration could not, or would not, coordinate actions to stop the run on banks affiliated with the Henry Ford family that began in Detroit, Michigan, in January 1933 [citation needed]. Federal Reserve chairman Eugene Meyer was equally ineffectual.

While many economic historians attribute the collapse to the economic problems which followed the Stock Market Crash of 1929, some economists attribute the collapse to gold-backed currency withdrawals by foreigners who had lost confidence in the dollar and by domestic depositors who feared that the United States would go off the gold standard,[7] which it did when Roosevelt signed Executive Order 6102, The Gold Confiscation Act of April 5, 1933.[8]

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

In the nineteenth and early twentieth 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.[9]

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 introduced in the Senate by Phil Gramm (Republican of 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[10] and by a bi-partisan 343–86 vote in the House of Representatives.[11] 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.[12]

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.[9]

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.[9]

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.[13] Elizabeth Warren,[14] author and one of the five outside experts who constitute the Congressional Oversight Panel of the Troubled Asset Relief Program, has said that the repeal of this act contributed to the Global financial crisis of 2008–2009.[15] [16]

The year before the repeal, sub-prime loans were just five percent of all mortgage lending.[citation needed] By the time the credit crisis peaked in 2008, they were approaching 30 percent.[citation needed] This correlation is not necessarily an indication of causation however, as 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.[17]

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.[18] 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.[19]

On January 21, 2010, Barack Obama proposed bank regulations similar to some parts of Glass–Steagall in limiting certain of banks' trading and investment capabilities. The proposal was dubbed "The Volcker Rule",[20] for Paul Volcker, who has been an outspoken advocate for the reimplementation of some aspects of Glass–Steagall[21] 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 that he was not advocating a return to Glass–Steagall or a complete separation between investment and commercial banking.[22] 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 become 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."[23]

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 Democratically-controlled 111th United States Congress and the Obama administration. The Act, which was passed as a response to the late-2000s recession, is the most sweeping change to financial regulation in the United States since the Great Depression, and represents a paradigm shift in the American financial regulatory environment impacting all Federal financial regulatory agencies and affecting almost every aspect of the nation's financial services industry. [In what ways and what institutions are affected?]

Harrison Morgan, president of the American Bankers Association, regarded the reforms as haphazard and dangerous, saying "To some degree, it looks like they're just blowing up everything for the sake of change […] [i]f this were to happen, the regulatory system would be in chaos for years. You have to look at the real-world impact of this."

But some experts have argued that the Dodd–Frank Act isn’t strong enough, arguing that it fails to protect consumers adequately, and, more importantly, fails to cut big and interconnected financial entities down to size.[24]

Think-tanks such as the CEE Council 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 traits of Keynesian complacency and unbridled deregulation that came to define the Clinton and Bush eras (1993–2009).[25] 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.

See also

References

  1. ^ "Frontline: The Wall Street Fix: Mr. Weill Goes to Washington: The Long Demise of Glass–Steagall". www.pbs.org. PBS. 2003-05-08. Retrieved 2008-10-08.
  2. ^ "The Repeal of Glass–Steagall and the Advent of Broad Banking" (PDF).
  3. ^ "GRAMM'S STATEMENT AT SIGNING CEREMONY FOR GRAMM–LEACH–BLILEY ACT".
  4. ^ "Obama takes on America's banks with new Glass-Steagall act". The Guardian. January 21, 2010.
  5. ^ http://mises.org/rothbard/agd/chapter11.asp
  6. ^ "FDIC: Important Banking Legislation".
  7. ^ http://mises.org/rothbard/agd/chapter12.asp
  8. ^ Gold Confiscation Act
  9. ^ a b c http://digital.library.unt.edu/govdocs/crs/permalink/meta-crs-9065:1 Cite error: The named reference "digital.library.unt.edu" was defined multiple times with different content (see the help page).
  10. ^ On Passage of the Bill (S.900 as amended ), retrieved 2008-06-19
  11. ^ On Agreeing to the Conference Report – Financial Services Modernization Act, retrieved 2008-06-19
  12. ^ "S. 900 [106th]: Gramm-Leach-Bliley Act". GovTrack.us. Retrieved 2010-10-17.
  13. ^ Barth; et al. (2000). "Policy Watch: The Repeal of Glass–Steagall and the Advent of Broad Banking" (PDF). Journal of Economic Perspectives. 14 (2): 191–204. {{cite journal}}: Explicit use of et al. in: |author= (help)
  14. ^ "Elizabeth Warren Pt. 2 - The Daily Show with Jon Stewart - 4/15/2009 - Video Clip | Comedy Central". Thedailyshow.com. 2009-04-15. Retrieved 2010-10-17.
  15. ^ Halligan, Liam (February 14, 2009). "Outrage at bonuses won't solve the mess we're in". The Daily Telegraph. London. Retrieved May 3, 2010.
  16. ^ Who's More to Blame: Wall Street or the Repealers of the Glass–Steagall Act?, retrieved 2009-04-07
  17. ^ McArdle, Megan (April 8, 2008). "History repeats . . . sort of". The Atlantic.
  18. ^ Hirsh, Michael (December 15, 2009), "McCain and Cantwell Want a New Glass-Steagall Law", Newsweek
  19. ^ Eckblad, Marshall (January 4, 2010), "Bank of America CEO Expects 'Long, Slow Recovery'", Wall Street Journal
  20. ^ Uchitelle, Louis (January 22, 2010), "Glass-Steagall vs. the Volcker Rule", The New York Times, retrieved 2010-01-27
  21. ^ Uchitelle, Louis (October 21, 2009), "Volcker Fails to Sell a Bank Strategy", The New York Times, retrieved 2009-12-17
  22. ^ Peston, Robert (May 14, 2010), "What Volcker Thinks", BBC, retrieved 2010-05-15 [dead link]
  23. ^ Carter, Zach (May 18, 2010), "How to Break Up the Banks, Stop Massive Bonuses, and Rein in Wall Street Greed", Alternet, retrieved 2010-05-18
  24. ^ Morgenson, Gretchen (June 25, 2010), "Strong Enough for Tough Stains?", New York times, retrieved 2010-06-25
  25. ^ Template:Fr icon Bank Regulation and Financial Orthodoxy: the Lessons from the Glass-Steagall Act (PDF), retrieved 2010-01-08

Further reading

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