Banking 101: The Glass-Steagall Act

The Glass-Steagall Act is older than Bob Dylan, “The Wizard of Oz” and the NBA, but its legacy still affects consumers every day.

Signed by President Franklin D. Roosevelt in 1933, the act was passed in response to the Great Depression and aimed to restore the public’s faith in the U.S. banking system. The result was a series of rules that radically changed America’s financial landscape.

Even though parts of the law were overturned by the Gramm-Leach-Bliley Act of 1999, Glass-Steagall remains a crucial part of how people deposit, borrow and invest their money.

But what is the Glass-Steagall Act, exactly? And why is understanding its rules so important? Here’s everything you need to know about the Glass-Steagall Act.

Why was the Glass-Steagall Act passed?

The Great Depression began as a financial and banking crisis, before turning into a global economic disaster. From 1929 to 1933, more than 4,000 branches closed nationwide, and in March 1933, President Franklin D. Roosevelt was forced to shut down the entire banking system for four days.

People were scared. As soon as the stock market crashed in 1929, customers started withdrawing their money from banks everywhere, knowing that their accounts were — at least in part — dependent on stock speculation.

Glass-Steagall set out to calm that fear. The law, officially called the Banking Act of 1933, was one of the first measures in President Roosevelt’s New Deal. Designated as emergency legislation to manage the financial crisis, the law created safety nets that helped secure consumer deposits.

The goal was simple: If people felt their money was safe with the banks, then they would finally start using them again.

How did the Glass-Steagall Act change banking?

Glass-Steagall may have started as emergency legislation, but its effects on banking have been far-reaching. Above all, the act was responsible for two major changes.

The first was the separation of commercial banks that take deposits — savings and checking accounts — and grant loans, and investment banks, which coordinate the purchase and sale of stocks and bonds. In the 1930s, many observers believed the lack of a clear distinction between the two was a source of corruption that contributed to the crisis that sparked the Great Depression.

Glass-Steagall sought to fix this problem. The law gave banks a choice: They could either manage deposits and loans, or deal in securities. The act gave banks one year to decide how they’d focus their business going forward.

The second major change was deposit insurance. Before 1933, financial institutions could invest their depositors’ money risk-free. This meant a bank could fall into debt using its customers’ accounts, then refuse to pay back the money it lost.

Glass-Steagall installed a safety net. The concept of deposit insurance was controversial at the time, but was ultimately added in thanks to support from Rep. Henry Steagall, the chairman of the House of Representatives’ Banking and Currency Committee who cosponsored the bill.

Glass-Steagall created the FDIC and the NCUA

In order to manage a system of nationwide deposit insurance, the act established the Federal Deposit Insurance Corporation (FDIC). The independent agency, which still exists today, is Glass-Steagall’s most lasting legacy.

Here’s how it works: The FDIC collects a pool of money from American banks, then uses that money to provide deposit insurance to their customers. Basically, the agency makes sure people don’t lose money just because their bank mishandles its finances.

The FDIC started by insuring deposits of up to $2,500, which quickly grew to $5,000 by July 1934. And that limit kept increasing: Today, the agency insures up to $250,000 per person, per bank. Its coverage includes nearly every bank in the country.

The organization also serves other functions, such as examining banks for financial soundness and making sure that financial institutions are in compliance with certain consumer protection laws. Its website even includes interactive tools, such as an online calculator, that tells people whether or not they have enough insurance for their accounts.

Glass-Steagall also paved the way for the National Credit Union Administration (NCUA), which serves a similar function as the FDIC. The NCUA wasn’t created by the Glass-Steagall Act itself, but instead by the Federal Credit Union Act, which was passed a year later in 1934.

Henry Stegall played again played an integral role in the creation of a U.S. financial agency, walking onto the House of Representatives floor and urging his colleagues to vote yes.

Just like the FDIC does with banks, the NCUA insures funds held in federally insured credit unions. Also, like the FDIC, the NCUA covers holdings of up to $250,000.

How the Gramm-Leach-Bliley Act changed Glass-Steagall

Glass-Steagall may live on through the FDIC and NCUA, but many of its provisions haven’t had the same longevity.

The biggest change to the law came in 1999 when President Bill Clinton signed the Gramm-Leach-Bliley Act. The legislation overturned entire portions of the Glass-Steagall Act.

Formally known as Financial Services Modernization Act of 1999, Gramm-Leach-Bliley was a response to the growing level of integration between commercial and investment banking.

The process started in the early 1980s. Commercial banks, which were supposed to stay out of securities markets, had started underwriting in stocks and bonds — some were even beginning to sell insurance. These practices seemed to contradict the commercial-investment separation laid out in Glass-Steagall, so the government decided to step in.

The result was a new set of rules that essentially erased those divisions. Gramm-Leach-Bliley created a new kind of financial institution — known as financial holding companies (FHCs) — which allowed banks to own both commercial and investment firms as subsidiaries under a larger umbrella company.

But these new privileges also came with new rules. The act also included restrictions to keep those things somewhat separate: For example, the new law limited the ability of one subsidiary to market its services to entities owned by the same FHC.

Contemporary calls to revive Glass-Steagall

Gramm-Leach-Bliley may not last forever though. There have been a number of calls to revive Glass-Steagall in the past decade, with many politicians saying a return to the commercial-investment separation would greatly improve the U.S. financial sector.

Some cite the watering down of the Glass-Steagall Act as one factor that helped create the housing bubble and financial crisis of 2007-08. Joseph E. Stiglitz, a Nobel laureate in economics and a professor at Columbia University, wrote in a Vanity Fair op-ed in 2009 that loosening the separation between investment and commercial banks was a big step backward. “There was a demand for the kind of high returns that could be obtained only through high leverage and big risk-taking.”

A 2011 bill in the U.S. House of Representatives aimed to repeal parts of Gramm-Leach-Bliley and “revive the separation between commercial banking and the securities business,” but the proposal never made it to the House floor for a vote.

Massachusetts senator and 2020 presidential candidate Elizabeth Warren has personally been an outspoken proponent returning to Glass-Steagall, introducing her own reinstatement attempt in 2017.

The bill, called 21st-Century Glass-Steagall Act, was presented as a modern version of the original law and gained support from both sides of the aisle — the late Republican Sen. John McCain even served as a cosponsor. President Trump told Bloomberg News at the time that he would consider the proposal, but the bill died in the committee before the Senate could hold a vote.

The attempts didn’t stop there, though. In April, Rep. Marcy Kaptur introduced the Return to Prudent Banking Act of 2019, which also aims to divide commercial and investment banking.

The bill hasn’t been voted on yet, but a number of high-profile House members, including presidential candidate Tulsi Gabbard and New York Rep. Alexandria Ocasio-Cortez have signed on as cosponsors.