The Glass-Steagall Act of 1933 established the Federal Deposit Insurance Corporation (FDIC) and became effective on January 1, 1934 for the purpose of banking reform. It was created in response to the stock market crash when people lost everything they had. Encouraging people to start saving again and to build confidence in the American banking system, this act set more stringent capital requirements and provided depositors with insurance on their deposits beginning at $2,500 worth of coverage. Today, depositors have $100,000 coverage on their deposits per account. The Glass-Steagall Act also banned any connection between commercial banks and investment banking for the purpose of preventing market speculation and causing future banking failures.
Two separate laws became known as the Glass-Steagall Act and both bills were sponsored by Democratic Senator Carter Glass from Lynchburg, Virginia, and a former Secretary of the Treasury, and Democratic Congressman Henry B. Steagall of Alabama who was also the Chairman of the House Committee on Banking and Currency.
- The first Glass-Steagall Act was passed in February 1932 in an effort to stop deflation, and expanded the Federal Reserve’s ability to offer rediscounts on more types of assets such as government bonds as well as commercial paper and providing financing to banks or other financial institutions. One of the provisions of the Glass-Steagall Act is Regulation Q which allowed the Federal Reserve to regulate interest rates in savings accounts. It also prohibited bank holding companies from owning other financial companies. For example, a stock brokerage firm could not own an insurance company or a bank and vice versa.
- The second Glass-Steagall Act, passed on June 6, 1933, was officially named the Banking Act of 1933 and introduced the separation of bank types according to their business (commercial and investment banking). Hence, the FDIC was established and provided and insured bank depositors with coverage.
Repealing the first Glass-Steagall Act
On March 31, 1980, President Carter signed into law the Depository Institutions
Deregulation and Monetary Control Act of 1980, the most important federal legislation
relating to the financial community since the 1930s. The act has nine titles covering a wide range of subjects, including reserve requirements, access to and pricing of Federal Reserve services, and a phase-out of Regulation Q and new powers for thrift institutions.
Repealing of the second Glass-Steagall Act
The bill that ultimately repealed the Act in its entirety was introduced in the Senate by Phil Gramm, (R) Texas and in the House of Representatives by Jim Leach, (R) Iowa and Tom Bliley, (R) Virginia which was known as The Gramm-Leach-Bliley Act. Passing this bill gave control to banks, securities firms and insurance companies to affiliate under common ownership which was previously prohibited under the Glass-Steagall Act. For example, Citicorp (a commercial bank holding company) merged with Travelers Group (an insurance company) in 1998 to form the conglomerate Citigroup, a corporation combining banking, securities and insurance services under a house of brands that included Citibank, Smith Barney, Primeria and Travelers. This combination was announced in 1993 and finalized in 1994. The Gramm-Leach-Bliley Act established the Federal Reserve as an umbrella supervisor. The new act was in direct opposition of the goals of the Glass Steagall Act and the Bank Holding Company Act of 1956 which prevented the combining of securities, insurance, and banking. The Gramm-Leach-Bliley Act was passed to legalize these mergers on a permanent basis, known today as the “financial services industry”. The bills were passed by a Republican majority, and the legislation was signed into law by President Bill Clinton on November 12, 1999. This victory for the banking industry which worked vigorously since 1980 to have the Glass-Steagall Act repealed now had unprecedented power in uncharted territory.
Elizabeth Warren co-author of ALL YOUR WORTH: The Ultimate Lifetime Money Plan (Free Press, 2005) (ISBN 0-7432-6987-X) is one of the five outside experts who constitute the Congressional Oversight Panel of the Troubled Asset Relief Program, has stated that the repeal of this act contributed to the global financial crises of 2008-2009.
Senator Byron Leslie Dorgan (D) North Dakota was and is one of the very few national political leaders who said, and is now saying, that the de-regulation of the financial system signed into law by Clinton on Nov. 12, 1999 was a horrible mistake.
Senator Byron May 6, 1999 on the deregulation of 1999 said, “This bill will, in my judgment, raise the likelihood of future massive taxpayer bailouts”. The New York Times reported that Senator Dorgan stated, “I think we will look back in 10 years’ time and say we should not have done this but we did because we forgot the lessons of the past, and that which is through in the 1930’s is true in 2010”.
The year before the repeal, sub-prime loans were just five percent of all mortgage lending. The repeal allowed the creation of mortgage banking products that were aggressive in nature with no underwriting common sense. By the time the credit crisis peaked in 2008, sub-prime loans were approaching thirty percent.
As a mortgage banker and with extensive knowledge of the Glass Steagall Act of 1933, and the repealing of it in 1999, I conclude that repealing the Glass-Steagall Act had a direct negative impact and was a major contributor to the collapse of the financial market in 2008-2009. The subsequent boom in the sub-prime market allowed many unqualified individuals to become homeowners and were saddled with ridiculous loans made available by the aggressive products that greedy financial institutions invented to line their own pockets with no warning to prospective homeowners. The laws that previously guarded against such wanton practice conveniently vanished. Many unscrupulous agents, brokers and lenders worked together to rake in huge profits while unwitting would be homeowners thought they were getting a piece of the “American dream”. Laws governing the separation of institutions that deal with capital markets and the traditional deposit-taking and working-capital finance markets must exist in order to create stability, accountability and safeguard against such economic disaster from happening again.