Glass Steagall Act

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  Economics

  The Definitive Encyclopedia from Theory to Practice [4 volumes]

  • David A. Dieterle(Author)
  • 2017(Publication Date)
  • Greenwood

    (Publisher)

  In 1933, Senator Carter Glass and Representative Henry Steagall introduced the Banking or Glass-Steagall Act. The main purpose of this historic legislation was to limit conflicts of interest between the banks and individual investors caused by the involvement of commercial banks in underwriting activities related to the security exchange. The new law prohibited commercial banks from underwriting securities. In addition, the banks had to choose between being a commercial bank or an investment bank. The Glass-Steagall Act also introduced the Federal Deposit Insurance Corporation (FDIC) to insure deposits of all commercial banks and to increase the control of the Federal Reserve over them. The deposit insurance and most provisions of the act were severely attacked during congressional debate, mainly for limiting competition and introducing inefficiency into the U.S. banking industry. Despite all opposition, the Banking Act of 1933 was signed into law by President Roosevelt on June 16, 1933.

  The law imposed numerous banking reforms and established the FDIC in the U.S. banking system. The Banking Act of 1933 had a significant number of provisions, many of which were changed or repealed over time. The provision that required all FDIC-insured banks to be members of the Federal Reserve System was repealed in 1939. In 1956, the Bank Holding Company Act extended banking regulations by restricting banks that owned other banks from engaging in nonbanking activities or acquiring banks in other states. During the 1960s and 1970s, bank lobbyists persuaded Congress to allow commercial banks to enter the securities market. By the 1970s, a number of investment firms started introducing some of the traditional commercial banking services, offering services such as money market accounts with interest, allowing check writing, and offering credit or debit cards.

  In 1986, the Federal Reserve Board bent the law by allowing commercial banks to earn up to 5 percent of their gross revenue from investment banking. Later, the Federal Reserve Board allowed the Banker Trust, a commercial bank, to actively participate in short-term credit transactions and underwriting activities. Finally, in 1987, after more than five decades of strong lobbying of big commercial and investment firms against the Banking Act of 1933, the Federal Reserve Board voted three to two in favor of easing the restrictions imposed by the act. In March 1987, despite strong opposition from Paul Volcker, the Federal Reserve Board chair at the time, the Fed approved an application by Chase Manhattan to participate in underwriting securities. In addition, the Fed increased the limit for participation of commercial banks in securities investment from 5 percent to 10 percent of their gross revenue.

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  New Economic Challenges – 5th International PhD Student Conference

  Collection of Annotations of Contributions

  • Oleksandra Lemeshko(Author)
  • 2017(Publication Date)
  • Masarykova univerzita

    (Publisher)

  All these were done against the backdrop that the existing global financial framework was not sustainable. The recent recession after the Great Depression pave the final way for the overhaul of the entire global financial and banking system. 3.1 Repeal of the Glass-Steagall Act The United States Congress in the middle of June 1933 passed the historic Banking Act of 1933, known as the Glass-Steagall Act, the objective of this act was to ban commercial banks from underwriting securi- ties and engaging in other related financial transactions which falls out of their jurisdiction. * Jeffrey D. Sachs, “With Friends like IMF...”, The (Cleveland) Plain Dealer, June 6, 1998. † Stiglitz spoke at a press briefing at the World Bank's Washington headquarters on Dec. 2, 1998. ‡ Ibidem. § http://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.13.4.21. ** Ibidem. 92 Traditional Banks were made to be commercial, that is held deposits and made loans respectively and also made in- vestment banks conduct securities transactions. "The Glass-Steagall Act also created the Federal Deposit Insurance Corporation, the FDIC. The FDIC insured bank deposits of commercial banks. In return for this insurance protection, the Federal Reserve Bank’s control over commercial banks was tightened." * "On the dawn of repeal, the late Senator Paul Wellstone made an impassioned plea on the Senate floor. He said the repeal of Glass-Steagall would enable the creation of financial conglomerates which would be too big to fail. Furthermore, he believed that the regulatory structure would not be able to monitor the activities of these financial conglomerates and they would eventually fail due to engaging in excessively risky financial transactions. Ultimately, he said, prophetically, that the taxpayers would be forced to bail out these too-big-to-fail financial institutions." † The whole idea of the Act was to restore public, consumer and investor confidence in the economy.

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  Current Legal Issues Affecting Central Banks, Volume I

  • INTERNATIONAL MONETARY FUND(Author)
  • 1992(Publication Date)
  • INTERNATIONAL MONETARY FUND

    (Publisher)

  Moreover, the vast majority of bank failures that occurred in the 1930s had little to do with “risky” securities dealing and underwriting, in that most of the failures occurred in smaller cities and rural communities as a result of local economic conditions and not of “investment banking” activities. In this sense, one legitimately may question whether the concerns addressed by the Act were, in fact, a primary cause of the economic dislocations of the times. 51 Insofar as the Glass-Steagall Act is credited with restoring confidence in the U.S. banking system, it can also be argued convincingly that the creation of federal deposit insurance was at least equally, if not more, responsible for restoring depositor confidence in commercial banks. Third, and in some respects most significant, the Glass-Steagall Act sought to create a barrier between lines of business (“banking” and “investment banking”) which in many respects served functionally interchangeable purposes and did so without a clear sense of the precise activities that ought to be prohibited. Thus, while a bank loan, on the one hand, and a flotation of debt securities, on the other hand, were simply different manifestations of the same basic function—that is, the extension of credit—one activity was legal after Glass-Steagall and the other was not. The various legislative reports, however, did not define the precise lines of demarcation between prohibited and permitted activities. Similarly, the assumption that commercial banks were not intended to venture into investment banking was largely belied by the fact that commercial banks had been involved in precisely these activities during the previous century; and even after the Glass-Steagall Act, they were permitted to continue engaging in highly significant securities underwriting businesses (e.g., dealing in and underwriting government obligations) and to provide services such as securities brokerage for customers

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  The Changing Face of American Banking

  Deregulation, Reregulation, and the Global Financial System

  • Ranajoy Ray Chaudhuri(Author)
  • 2016(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Finally, Section 32 made it illegal for any individual involved in any aspect of an investment banking establishment from serving as an officer, director, or employee of a national or state bank that was a member of the Federal Reserve System. Critics pointed out that a blanket ban on securities-related activities was not the solution. The Glass-Steagall Act made it illegal for banks to own even safe blue chip stocks with high returns but allowed them to continue making risky real estate loans or international loans. Additionally, assuming that there was enough information, the risk premium would be incorporated into the pricing of the loan. More risky loans should simply carry a higher interest rate. 8 However, information is not always perfect; that continues to be true even today, even within organizations. This is especially true of large corporations with multiple divisions that work autonomously. Cash-strapped regulatory agencies that can’t perform their jobs properly or regulatory agencies that have a conflict of interest greatly compound the problems. Supporters can also point to the unprecedented The Great Depression and the Glass-Steagall Act ● 79 five-decade-long period of stability in the banking sector following the passage of the act. There had been many attempts at passing a deposit insurance bill in Congress prior to the establishment of the FDIC. A representative from Wisconsin intro- duced a deposit insurance bill in the House as far back as 1886. Other bills, 17 of them, followed by 1900, but none cleared Congress. Between 1886 and the inception of the FDIC, 150 separate proposals for the establishment of a deposit insurance program came up in Congress; the sponsors came from 30 states from all over the country and were almost equally divided between the Democrats and the Republicans. Individual states hence began experimenting with deposit insurance.

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  Regulation of Banks and Finance

  Theory and Policy after the Credit Crisis

  • Carlos A. Peláez, Carlos M. Peláez(Authors)
  • 2009(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  The Glass-Steagall Act The internal structure of firms is of importance to theory, regula- tory policy, and the concern of the NIE with the nature of the firm. Regulation could impose structures on firms to ameliorate market fail- ures and solve conflicts of interest. Kroszner and Rajan (1997) analyzed theoretically and empirically the structure of US investment banking by commercial banks before the 1933 Glass-Steagall Act forced banks to exit securities underwriting. The combination of lending and investment banking can lead to conflicts of interest based on information asymmetries. There could be moral hazard in that the commercial side of the business could force the investment banking side to issue securities of companies in difficul- ties, misrepresenting their actual financial state to the public and using the proceeds from the issue of securities to repay the loans to the com- mercial part of the bank. Knowledge of the financial state of companies could lead to adverse selection as banks could “cherry pick” the sound clients, leaving the others to be financed in the securities markets. The contribution of Kroszner and Rajan (1997) for the period before the Glass-Steagall Act analyzes a sample of 43 internal departments and 32 securities affiliates of commercial banks and trusts involved in investment banking underwriting of 906 securities. They find evidence that outsiders recognize the conflict of interest between commercial and investment banking. The prices of securities underwritten by the inter- nal departments of banks, perceived as having higher potential conflict of interest, were discounted relative to those of securities underwritten 122 Regulation of Banks and Finance by independent affiliates, with lower perceived conflict of interest. They conclude that internal structure matters in the competitive edge and market perception of companies.

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  An Introduction to Financial Markets and Institutions

  • Maureen Burton, Reynold F. Nesiba, Bruce Brown(Authors)
  • 2015(Publication Date)
  • Routledge

    (Publisher)

  This reduced the costs of maintaining a separate board of directors for each bank and the costs of other duplicative overhead expenses. Whether significant savings will be realized remains to be seen. We turn now to the final major piece of banking legislation in the twentieth century. With the passage of the Gramm-Leach-Bliley Act in 1999, the financial services industry of the twenty-first century is far different from that of the twentieth century. The Gramm-leach-bliley Act (glba) of 1999—The Final Demise of Glass-steagall Until 1999, the most significant piece of banking legislation in the twentieth century had been the Glass-Steagall Act of 1933, which separated investment and commercial banking, created the FDIC, and limited the range of assets and liabilities that a commercial bank could hold and issue. After 67 years, this act was effectively repealed with the passage of the Gramm-Leach-Bliley Act (GLBA) in November 1999. The new landmark legislation became effective March 11, 2000, and it significantly impacts the financial services industry. Rather than segmentation among financial service providers, the act allows for considerable financial integration in the financial services industry. Major Provisions of the Gramm-Leach-Bliley Act GLBA allows bank holding companies that meet certain criteria to be certified as financial holding companies (FHCs). FHCs may engage in a broad array of financial and nonfinancial activities. To become an FHC, a bank holding company must file a declaration with the Fed that certifies that all of its depository institutions are well capitalized and well managed and have a “satisfactory” or better rating under the Community Reinvestment Act

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  Wall Street Wars

  The Epic Battles with Washington that Created the Modern Financial System

  • Richard Farley(Author)
  • 2015(Publication Date)
  • Regan Arts.

    (Publisher)

  FOUR

  MORE LIVES THAN A CAT:

  The Glass-Steagall Banking Act of 1933

  The success of the bank reopenings earned Roosevelt an unexpected windfall of political capital for financial reform. But how best to deploy it—or how not to squander it—was not a simple matter. So much needed to be done and every option was fraught with risk. Roosevelt knew that Wall Street was flat on its back after the disastrous performance by the National City Bank officers at the Pecora Hearings and the humiliation of the nationwide bank shutdown and bailout. But he also knew that Wall Street would bounce back, and when it did, it would fight any permanent reform proposals tooth and nail. Time was not the president’s ally.

  Roosevelt’s skeletal financial reform agenda had four essential elements: first, “truth in advertising” in the sale of new securities; second, elimination of stock manipulation and unfair dealing on the securities exchanges; third, stricter control over margin lending to limit stock speculation; and fourth, the separation of commercial banking and investment banking.

  In broad strokes, Roosevelt outlined his seven-point reform program to implement this agenda during an August 20, 1932, campaign speech in Columbus, Ohio:

  “Government cannot prevent some individuals from making errors of judgment. But Government can prevent to a very great degree the fooling of sensible people through misstatements and through the withholding of information on the part of private organizations, great and small, which seek to sell investments to the people of the Nation. First, toward that end and to inspire truth telling, I propose that every effort be made to prevent the issue of manufactured and unnecessary securities of all kinds which are brought out merely for the purpose of enriching those who handle their sale to the public; and I further propose that with respect to legitimate securities the sellers shall tell the uses to which the money is to be put. This truth telling requires that definite and accurate statements be made to the buyers in respect to the bonuses and commissions the sellers are to receive, and, furthermore, true information as to the investment of principal, as to the true earnings, true liabilities and true assets of the corporation itself. Second, we are well aware of the difficulty and often the impossibility under which State Governments have labored in the regulation of holding companies that sell securities in interstate commerce. It is logical, it is necessary and it is right that Federal power be applied to such regulation. Third, for the very simple reason that many exchanges in the business of buying and selling securities and commodities can by the practical expedient of moving elsewhere avoid regulation by any given state, I propose the use of Federal authority in the regulation of stock exchanges. Fourth, the events of the past three years prove that the supervision of national banks for the protection of the public has been ineffective. I propose vastly more rigid supervision. Fifth, we have witnessed not only the unrestrained use of bank deposits in speculation to the detriment of local credit, but we are also aware that this speculation was encouraged by the Government itself. I propose that such speculation be discouraged and prevented. Sixth, investment banking is a legitimate business. Commercial banking is another wholly separate and distinct business. Their consolidation and mingling are contrary to public policy. I propose their separation. Seventh, prior to the panic of 1929, the funds of the Federal Reserve System were used practically without check for many speculative enterprises. I propose the restriction of Federal Reserve Banks in accordance with the original plans and earlier practices of the Federal Reserve System under Woodrow Wilson. Finally, my friends, I propose two new policies for which legislation is not required. They are policies of fair and open dealing on the part of the officials of the American Government1

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  Freedom to Harm

  The Lasting Legacy of the Laissez Faire Revival

  • Thomas O. McGarity(Author)
  • 2013(Publication Date)
  • Yale University Press

    (Publisher)

  They were subject to antifraud laws administered by the Federal Trade Commission (FTC) and (if they were publicly traded corporations) to modest minimum capital requirements pro-mulgated by the Securities and Exchange Commission (SEC). To ensure that federally insured banks did not engage in overly risky investments, the Glass-Steagall Act prohibited them from functioning as investment banks, securities dealers, or insurance companies. 3 Congress enacted the Truth in Lending Act of 1968 (TILAct) to curb “preda-tory lending,” a generic term for deceptive, manipulative, and overly aggressive lending practices that are especially prevalent in markets where borrowers are less educated, have limited access to mainstream banks, and lack the tools nec-essary to engage in comparison shopping. The statute required lenders to dis-close in a standardized format using comprehensible language specific aspects of covered loan agreements, including the annual percentage interest rate and the total finance charge. In addition, lenders had to inform consumers of late fees, security interests, and other loan characteristics that would facilitate loan comparisons. Finally, the consumer had a right to rescind the agreement within three days if the creditor received a security interest in the consumer’s home. 4 166 The Laissez Faire Revival These statutes provided significant protections to consumers on both ends of transactions with banks. Consumers depositing modest sums of money in a bank could be confident that it would invest them wisely and pay the promised interest, without having to worry about the possibility of a run on the bank. Borrowers could rest assured that the relevant terms and conditions of loans were apparent in the lending documents and that they could back out of agree-ments if deeper reflection revealed that the terms were unacceptable or unaf-fordable.

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  The Chicago Plan and New Deal Banking Reform

  • Ronnie J. Phillips, Hyman P. Minsky(Authors)
  • 2016(Publication Date)
  • Routledge

    (Publisher)

  The Administration bill was introduced by Senator Duncan Fletcher in the Senate (S. 1715) and Congressman Steagall in the House (H.R. 5357) on February 5, 1935. Title I of the bill made Federal Deposit Insurance permanent, Title II contained amendments to the Federal Reserve Act, and Title III included technical amendments. The debate over the bill centered on Title II which sought to give greater powers to a revised Federal Reserve Board whose members would be appointed by the president. Senator Carter Glass denounced the Eccles bill as the most dangerous and unwarranted measure of the entire New Deal (Sandilands 1990, 64).

  Senator Duncan Fletcher, in noting the importance of, and opposition to, the bill stated:

  In my opinion, the proposed Banking Act of 1935 is, in all probability, the most important piece of banking and monetary policy legislation with which this or any other Congress has dealt. This statement is based upon the importance of title II alone and, curiously enough, title II of the bill is bearing the brunt of almost all of the opposition made to the entire piece of legislation. Please be advised, however, that all of those who are offering concerted opposition to the bill on the basis of the incorporation of title II are almost spontaneous in their clamor for the enactment of titles I and III. (Congressional Record, 1935, 6102)

  In putting forth the bill, Fletcher continued, the administration was fulfilling a promise to improve the conduct of monetary policy:

  Title II… deals almost wholly with the creation of machinery for the effective regulation of a definite monetary policy in accordance with the campaign promises of President Roosevelt based on the Democratic platform of 1932 which advocated “a sound currency to be preserved at all hazards” and proposed to put an end to “the indefensible expansion and contraction of credit for private profit at the expense of the public.” (Congressional Record, 1935, 6103)

  Fletcher argued that the provisions of Title II did not represent a radical departure from that which had been legislated. He noted in particular that the Banking Act of 1933 created the open market committee, and the Thomas Amendment to the Agricultural Adjustment Act gave the Board, in periods of crisis, the power to “increase or decrease from time to time, in its discretion, the reserve balances required to be maintained against either demand or time deposits” (Congressional Record

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  Financial Structures and Regulation: A Comparison of Crises in the UK, USA and Italy

  • A. Roselli(Author)
  • 2011(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  The GLB Act extended these provisions of Sections 23 A and B to flows of funds between banks and their own financial subsidiaries and between holding companies and financial subsidiaries of the bank. The Act mandated the FED to regulate the matter, in relation to the new legislative framework, which permitted the coexistence of commercial banks and investment banks Crisis of the Shadow Banking System 179 as affiliates under the same FHC umbrella. The Act also required the FED Board to address the applicability of Sections 23A and B to derivatives trans- actions between banks and their affiliates. In 2002, after a long consultation, the FED issued Regulation W, confirming the main lines of interpretations already given. Two points deserve attention, however: with regard to deriva- tives transactions, the Regulation excluded them from the limit of 10/20 per cent of Section 23 A. It confirmed the applicability of “market terms” as per Section 23 B. The reference to market terms was very dubious for opaque financial instruments such as CDOs which, in the end, had no market at all. As to whether the SPEs should be considered as bank affiliates, and therefore subject to the mentioned Sections of the Federal Reserve Act, or rather as third parties to the bank, and therefore excluded from the applicability of the two Sections, the FED chose to defer any ruling. In Henry Kaufman’s opin- ion, the FED was led by a libertarian dogma: it allowed the Glass–Steagall Act to succumb without appreciating the negative consequences of permit- ting investment and commercial banks to be put together; it also failed to recognize the significance of structural changes in the markets, because liq- uidity, traditionally an asset-based concept, was shifted to the liability side. Liquidity became synonymous with easy borrowing, excessive credit growth and unrestricted profit seeking, all factors that might suddenly disappear.

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