Definition
The Glass-Steagall Act was a U.S. legislation passed in 1933 that separated commercial banking from investment banking activities. It was enacted after the Great Depression to minimize financial risk and prevent a repeat of market crash by creating a wall between retail and investment banking. However, the Act was partially dismantled in 1999, allowing banks to again expand their services.
Key Takeaways
- The Glass Steagall Act refers to a law passed in 1933 that was aimed at controlling the risk-taking by banks which initiated the Great Depression. It primarily sought to separate commercial banking from investment banking.
- The Act’s objective was to prevent banks from using depositors’ funds for risky investments in the stock market. It also established the Federal Deposit Insurance Corporation (FDIC), which insured bank deposits to instill confidence in the banking system among the public.
- However, the Glass Steagall Act was partially repealed in 1999 by the Gramm-Leach-Bliley Act. Critics argue that its repeal was one of the causes of the 2008 financial crisis because it allowed banks to again enter into risky financial practices.
Importance
The Glass-Steagall Act, enacted in 1933, is significant in the realm of finance because it introduced profound reforms to the banking industry during the Great Depression by implementing a separation between commercial and investment banking.
The legislation aimed to mitigate risky financial speculations and to protect bank depositors’ funds from being used for high-risk speculation on Wall Street.
It established the Federal Deposit Insurance Corporation (FDIC), ensuring customer deposits, thus restoring public confidence in the banking system.
The Act’s influence diminished when it was largely repealed in 1999, leading to debates about its role in the 2008 financial crisis.
Explanation
The Glass Steagall Act was enacted in 1933 with the purpose of restoring public confidence in the banking system during the Great Depression. The crash of 1929 and the ensuing financial crisis exposed significant flaws in the U.S. banking structure, leading to high-risk investment activities and rampant speculation.
The Glass Steagall Act was designed to prevent such risky business practices and shield depositors’ funds from being used for high-risk speculation. Its central feature was to create a wall between commercial banking and investment banking. Prior to the Glass Steagall Act, commercial banks were allowed to engage in investment banking activities, where they would underwrite and trade securities.
However, this integration of roles resulted in conflicts of interests and excessive risk taking. The Act prohibited commercial banks from dealing with securities, thereby reducing the risk for depositors and mitigating the likelihood of bank failures. It was intended to make the banking system safer by separating the riskier securities business from traditional banking activities like deposits and loans.
This separative measure sought to protect consumers and prevent future financial catastrophes.
Examples of Glass Steagall Act
JP Morgan Chase: Before the Glass-Steagall Act was repealed in 1999, banks like JP Morgan Chase were prohibited from engaging in both commercial and investment banking activities. However, with the repeal of the Glass-Steagall Act, JP Morgan Chase was able to expand its services to include both, becoming a global financial service provider offering services like investment banking, commercial banking, asset management and so on.
Citigroup: In 1998, Citigroup was created from the merger of Citicorp and Travelers Group. However, at the time, the merger was not fully legal as Citicorp was a pure commercial bank and Travelers Group was an insurance company with an investment arm. Hence, the structure of Citigroup violated the Glass-Steagall Act which prohibited any one institution from acting as any combination of an investment bank, a commercial bank, and an insurance company. But a year later, Glass-Steagall was repealed, making the broad structure of Citigroup legal.
2008 Financial Crisis: Following the repeal of the Glass-Steagall Act, many large banks significantly expanded their investment operations. They began dealing in complex derivatives and securities, such as mortgage-backed securities. When the housing market collapsed in 2008, these securities declined significantly in value, contributing to the 2008 financial crisis. Many economists and financial experts argue that the repeal of the Glass-Steagall Act was a key contributor to the severity of the crisis.
FAQs about The Glass Steagall Act
What is the Glass Steagall Act?
The Glass Steagall Act, officially known as the Banking Act of 1933, is a law designed to separate commercial and investment banking. Its goal was to prevent future banking crises by imposing regulations that prohibit commercial banks from engaging in risky investment activities.
Why was the Glass Steagall Act implemented?
The Glass Steagall Act was implemented in response to the Great Depression. The stock market crash of 1929 and the ensuing bank failures led to widespread economic loss and hardship. The Act was created to restore public confidence in the U.S. banking system.
Is the Glass Steagall Act still in effect today?
No, the primary provisions of the Glass Steagall Act were repealed in 1999 by the Gramm-Leach-Bliley Act.
What did the repeal of the Glass Steagall Act mean for the banking industry?
The repeal of the Glass Steagall Act allowed commercial banks, investment banks, and insurance companies to consolidate and offer a wider range of financial services. However, it is also often debatable that its repeal may have contributed to the financial crisis of 2008 by allowing risky financial practices.
What was the purpose of the Glass Steagall Act?
The primary purpose of the Glass Steagall Act was to prevent the use of deposits for risky investments, thereby protec
ting depositors. It also aimed to restore trust in the banking system following the Great Depression.
Related Entrepreneurship Terms
- Commercial Banking
- Investment Banking
- Financial Regulation
- Banking Crisis
- Federal Reserve System
