The Glass-Steagall Act of 1933: Ethics and Law in Business and Society

Introduction

The purpose of this policy paper is to understand the history behind the Glass-Steagall Act of 1933 and evaluate its main purpose towards society. This research paper will discuss the policy’s effectiveness and implementation towards public policy, it strengths and weaknesses and recommendations for future policy makers.

History of the Act

Officially known as the banking act of 1933, this legislation established the idea of deposit insurance and the creation of the federal deposit insurance corporation. Then it became known as Glass Steagall Act thanks to implementation of separating commercial banking from investment banking. Commercial banking was involved in deposits and making loans while investment banking focuses more on selling bonds and stocks. Before the Glass Steagall Act, banks were operating both activities under one establishment. The banking act also allowed national banks to engage in branch banking which lets banks accept deposit and make loans away from their established location. The law was necessary in response to the 1929 stock market crash and commercial banks nationwide failed. Banks were engaging in risky speculation at the expense of depositors’ money, in other words, banks made risky loans to companies and clients. During 1929 and 1933, more than four-thousand banks failed, losing an estimated amount of four-hundred million dollars of depositors’ money. In response,
President Roosevelt shutdown the entire banking system for four days. Due to the events leading up to the crash, the result showed that banking and securities underwriting is a bad combination because banks would underwrite bad securities to unsuspecting investors (Lardner). The Glass-Steagall act gave banks a year to decide either to focus on commercial banking or investment banking.   According to the journal, “Democracy and Productivity- The Glass-Steagall act and reshifting discourse of financial regulation,” by K. Sabeel Rahman, “By Spring 1933, the Glass bill merged with legislation pushed by Henry Steagall in the house to create a deposit insurance system by establishing what is now the FDIC. With the added deposit insurance provisions, the combined banking act passed congress easily in June 1933, signed into law by Franklin Roosevelt shortly thereafter,” (613). The intentions of the Glass Steagall Act was meant to bring stability and integrity to the banks in America.

The 1932 act accomplished three objectives. First, the FED were able to underwrite Federal Reserve notes with government securities. At the same time, the currency needed to be supported by gold. Second, collateral was decreased for FED member banks who engaged in discount transactions. Third, the Federal government was able to loan to other countries’ gold reserves. In the same manner, the banking act of 1933, known as the Glass-Steagall act, accomplished three main objectives. It prevented commercial banks from owning securities brokerage firms. A deposit insurance program was established under the Federal Reserve and regulation Q prevented interest payment on commercial checking accounts and limited the interest rate on saving accounts, (Glass-Steagall Act-(P.L. 73-66, 48 Stat. 162). Congress also passed a similar act separating banking and insurance. Then the bank holding act of 1956 allowed banks to sell insurance but underwriting insurance was not permitted. Anti-regulation advocates gained momentum in the 1980’s in weakening the financial regulatory structure. According to the bill, a bank cannot own more than ten percent of a non-banking entity, and industrial company cannot own a bank. In 1998, Sanford Weil, the interim financier, proposed a merge to Citicorp’s John Reed. This was a violation of the Glass-Steagall act, but under the presidency of Bush, Greenspan convinced the Feds to allow bank holding companies to own investment banks up to twenty-five percent of security underwriting (Lardner). In 1999, Clinton signed the Gramm-Leach-Bliley into law which repealed the provisions of the Glass-Steagall Act. The Glass-Steagall act matters because it addressed a market failure in the financial industry. Banks were speculating with depositors’ money, and when the investment did not go well, the depositors were affected the greatest. Hardworking citizens put their trust in banks to hold their lives work, and banks became greedy looking for that profit. What was really wrong about how banks were behaving is that they knew they were getting into bad investments and persuaded clients to take on those risks. The bank owners get rich with depositors’ money and ordinary people are left dirt poor. The Glass-Steagall was necessary because it brought back stability and trust in the banks.

Market failure

The policy was a response to a market failure, banks were failing due to corporate fraud with negative effects on society. People lost their life’s savings. At the same time, over time, the repealment of the act showed that it was a government failure as well. The financial society believed the act was harsh and prevented banks from competing internationally. Although, banks were limited in their power to compete internationally, they believe that the industry can self-regulate without tough provisions from the Glass Steagall Act. This way, banks were able to operate in both commercial and investment banking. The repealment only proved that banks have become too intertwine to regulate and control. With this power, banks have the freedom to continue to speculate in risky investments and the proof is in the housing fraud crisis of 2008. There were other regulations implemented to substitute the Glass-Steagall act like the Dodd-Frank Act. This act is a Wall Street reform and consumer protection act which was passed by the Obama administration. The Consumer Financial Bureau was established to prevent predatory mortgage lending. The problem with this legislation is that it is relatively new and it would take years before there is a clear understanding of it implication powers.

Current Situation

Currently, many believe the banks are behaving more recklessly and could cause the next financial crisis. In the article, “Too Big to Fail and too big to Exist,” by William J Quirk, ‘in 2011, Phil Angelides, chairman of the U.S. Financial Crisis inquiry Commission, summarized the problem: ‘These banks are too big to fail; they are too big to manage, they’re too big to regulate. They’re too complex to understand and they’re too risky to exist. And the bottom line is they offer very little benefit,’ (32). This signifies how much commercial banking, investment banking and insurances are intertwined, meaning that these banks cannot fail because it would could a chain reaction and cause the entire financial system in the United States and in other countries to fail. That is why the Federal Reserve bailed the big banks with taxpayer money. This structure only fuels the culture that banks can do anything because they are insured bailout if there speculative investment don’t turn out. This is a serious problem that the Glass-Steagall act could have prevented banks from becoming too big to fail. According to Quirk, “As bank profits doubled, the wealth of American families plummeted. House values dropped, and almost a quarter of mortgages are now underwater. Median income has dropped. By almost every measure, ordinary people are worse off… The cause of the crisis, the people believe, was simple greed together with a complicit government willing to take on illegitimate debt,” (40). Without the regulatory provisions separating commercial and investment banking by the Glass-Steagall Act, banks that have become too intertwined with commercial and securities underwriting have too much power to be regulated efficiently. During the time Glass-Steagall was implemented, they were bank failures but none would devastately affect the entire financial system. After the repealment, the banks’ combination of investment and commercial activities lead to the 2008 crisis. In response to the crisis, the Bush and Obama administration believe that the banks cannot fail and bailed them out with “… An outstanding $23.9 trillion to support the banks. Otherwise, the government said, the sky would fall,” (40). The sky did fall, but on the taxpayers. Banks are still running, but at the cost of the public. This too big to fail banks hold the financial stability of not only the United States but foreign economies.

Traces of implementation

The major title of the Glass-Steagall Act of 1933 is found in chapter 89, H.R. 5661. Public, NO. 66. The act was created “to provide for the safer and more effective use of assets of banks, to regulate interbank control, to prevent the undue diversion of funds into speculative operations and for other purposes. Be it enacted by the Senate and House of Representatives of the United States of America in congress assembled, that the short title of this Act shall be ‘Banking Act of 1933.’ (Chapter 89, section one). In other words, the constitutional law to separate commercial and investment banking activities. There were two agencies created by this act. The first, The Federal Deposits Insurance Corporation (FDIC) which was in charge of earning the people’s trust in banking by making sure their deposits will be safe if a bank closes. This agency was established in section 12.B. sub-section (a), where among many responsibilities, its main duty is “…to insure, as hereinafter provide the deposits of all banks which are entitled to the benefits of insurance under this section.” Other corporate powers of the (FDIC) are mentioned in section 12.B. sub-section (j). The second agency is the Federal Open Market Committee (FOMC) under the Federal Reserve. The main power of this agency is to determine U.S monetary supply and money policy. This agency was created in section 12.A. sub-section (a). “There is hereby created a Federal Open Market Committee {hereinafter referred to as the ‘Committee’}, which shall consist of as many members as there are Federal Reserve districts.” These two agencies were responsible for regulating banking activities under the Glass-Steagall Act. Even though the Glass Steagall was repeal in 1999, these two agencies remained in power.

Impact on business and society

  The Glass-Steagall had major impacts when it was implemented in 1933. It benefited society because their deposits were safe from bank speculation activities. With over 5,000 banks failing nationwide the great amount of deposits lost during the market crash of 1929, devastated many citizens. Not only that, people did not trust banks and many people would get their money out before the bank failed, even though the bank was not going to fail. People didn’t trust in banks and did not want to become victims. It is unfair for hard working citizens placing their lifetime savings, their fruits of their labor into banks, and then finding out that the bank can’t give their money bank. This is outrageous because bankers would gamble with peoples’ money and would take risky investment in order to make extra profit. In the article, “The Man in the Street is for It”: The Road to the FDIC” by Christopher W. Shaw describes the pain of people who suffered from the crisis. Shaw mentions, “working people are the greatest sufferers in bank failures,’ observed one Chicago tailor, who affirmed that ‘[a] great deal of this is caused-by the dishonesty of bankers.’ Sensational cases of banker criminality were abundant and they further undermined confidence in banks,” (44). It is funny to think that when people rob banks, they get sent to jail and punished for it, but when banks robbed peoples’ deposits, they did not go to jail. That is why the Glass-Steagall Act was a necessary government intervention. The act protected consumers’ from bank fraud. Also, consider the lives of the people who were affect by this crisis. The deposits came from people who probably have a small salary, worked long hours and worked really hard. What happens then is that they find out that their entire life savings is gone! This was wrong. What the Glass-Steagall did for society is bring back security to their lives.

 The Glass-Steagall also had major effects on businesses, especially in the banking industry because they fought hard to repeal the GSA. Referring to the bank industry, banks were producing low profitability and availability of finance for industries was low. The most important was that banks were becoming less competitive internationally with foreign banks. Rahman mentions, “First, a host of empirical studies in the 1980’s and 1990’s sought to argue that banks  with securities affiliates in the 1920’s were not in fact selling risky assets, and were less likely to fail. Meanwhile, market pressures, it was argued, forced banks to self-regulate by offering higher-quality securities…Regulation thus became a constraint rather than an enabler of economic productivity,” (636). In this case, after the GSA was implemented, it would be considered a government failure because the act prevented banks from competing internationally, but at the same time, the reason for the GSA was to prevent speculation with depositors’ money. This was evident during the Great Depression, many banks failed and a huge amount of deposits were lost. One reason why the act was repealed in 1999, was for United States banks to compete internationally.

Policy analysis

 During the Market crash of 1929, the Glass-Steagall Act did succeed in bringing back stability to the financial system. It separated commercial banking and investment banking where banks engage in speculation with depositors’ money without any regulation. This encourage fraud among bankers. The whole U.S financial system was wrecked because over 5,000 banks failed worldwide which made other depositors take out their money from banks causing those banks to fail as well. Also, the people were the most that suffered because over 400,000 million dollars of depositors’ money was lost. The Glass-Steagall did implement strict regulation on banks by creating a firewall between commercial and speculative banking. In the same manner, two agency were responsible in regulating the activities of banks. The Federal Deposit Insurance Corporation which insured depositors’ money, and the Federal Open Market Committee which was responsible for determining U.S monetary supply and policy. The Glass-Steagall was a necessary government intervention. The act regulated banks through the years up to 1999 when some of its provision were removed by the Gramm Leach Bliley act. Anti-regulation movements, mainly banks, wanted to repeal the act. Through the new act, most of the provisions covered by the GSA was removed, letting banks revert back to combining investment and commercial banking. Experts mention that the repealment caused the financial crisis of 2008 where the government bailed out the too big to fail banks. 23.9 trillion of taxpayer money was used to bail the banks. Without the Glass-Steagall act, banks were allowed to merge commercial and investment activities which led the corporations to become a complicated system of intertwined activities of different companies who handled commercial and securities underwriting. This lead to accumulated power to banks, they are too big to regulate. Now the main debate is to break up the big banks, but in reality, how would that be possible if they have become so intertwined with other economies and have become complicated to regulate. Would breaking up the big banks cause a devastating financial crisis that would affect all the economies around the world? Without a doubt, experts expect another financial crisis near the future. The best solution for future policy makers is to reinstate an updated version of the Glass-Steagall Act. It worked back in the market crash of 1929, it could work now. Supporters like Bernie Sanders believe that breaking up the big banks is the next step to secure the financial system. Opposition towards breaking up the banks is Hilary Clinton which believes that the reinstatement of the Glass-Steagall is not necessary because her new policy will be tougher on big banks. As how things look right now, the big banks do have a lot of power, and if it’s going to cost taxpayers’ trillions of dollars to bail them out again for irresponsible activities, then I believe the best solution is to reinstate a new version of the Glass-Steagall act.

Appendix pages

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 (Glass-Steagall Act-P.L.73-66, 48 Stat. 162.)

Reference page

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