Glass-Steagall Act: Why Was It Repealed, and What Did It Do?

The Glass-Steagall Act said banks that hold consumers’ deposits couldn’t heavily invest in most securities.

The law was passed in 1933 to keep deposits safe from market crashes, but it was replaced in 1999 after banks complained that the rules made it hard to compete against foreign rivals.

During its time, Glass-Steagall radically changed America’s banking landscape, and its legacy is still debated today.

What is the Glass-Steagall Act?

President Franklin D. Roosevelt signed the Glass-Steagall Act into law in June 1933 as bank failures sapped confidence in the banking system.

The new rules limited commercial banks, which hold customers’ savings and other deposits, from getting more than 10% of their income from securities trading, except for government bonds.

Likewise, investment banks, which do trade in securities, were barred from commercial banking activities.

The Glass-Steagall Act also created the Federal Deposit Insurance Corp. (FDIC) to insure bank deposits. The FDIC still exists today, covering consumers’ deposits up to $250,000.

Provisions of the Glass-Steagall Act

To keep banks from speculative investing, the Glass-Steagall Act had four main provisions separating commercial and investment banking:

• Section 16 prohibited banks from dealing in and underwriting most securities.
• Section 20 prohibited banks from affiliating with businesses that “engaged principally” in securities activities.
• Section 21 prohibited both deposit taking and investment banking by the same bank.
• Section 32 prohibited directors and other employees from serving with both a bank and securities firm.

Why was Glass-Steagall repealed?

Over time, concerns grew that the Glass-Steagall Act put U.S. banks at a disadvantage compared with international peers. A big problem was that they couldn’t underwrite securities like some foreign banks could.

Regulators began loosening some of the rules in the 1960s, and by the 1980s debate over repealing Glass-Steagall grew.

In 1999, the Gramm-Leach-Bliley Act was passed, throwing out much of Glass-Steagall. The new law created financial holding companies, which could own both commercial and investment banks. The Federal Reserve was given the job of supervising these new entities.

Did Glass-Steagall’s repeal cause the Great Recession?

In 2007, U.S. home prices began dropping, leading to the Great Recession of 2007–2009 and a global financial crash in 2008 as housing-based investments hit the banking sector.

In the aftermath, debate started over whether the end of Glass-Steagall had driven the collapse.

For example, Nobel Prize-winning economist Joseph Stiglitz said that ditching Glass-Steagall changed the “entire culture” of the banking industry.

“When repeal of Glass-Steagall brought investment and commercial banks together, the investment-bank culture came out on top,” Stiglitz wrote in 2009.

“There was a demand for the kind of high returns that could be obtained only through high leverage and big risk-taking.”

But others argue that different factors, including a boom in subprime lending, were the real causes of the crisis, rather than the Glass-Steagall repeal.

What is the Volcker Rule?

While Glass-Steagall is gone, new laws have brought back some of its restrictions on banks and securities firms.

In 2010, Congress passed the Dodd-Frank Act to prevent the excessive risk-taking that led to the financial crisis and to protect consumers.

The new law included the so-called Volcker Rule, which stops banks from using its depositors’ funds for high-risk investments.

Although the banks can use some of their own money for investing, the Volcker Rule also prohibits them from owning more than 3% of a private equity fund or hedge fund.

The rule is named after former Federal Reserve Chairman Paul Volcker, who proposed it as a way to curb banks’ speculative trading that did not benefit consumers.