Glass-Steagall Act of 1933: Definition, Effects, and Repeal

What Is the Glass-Steagall Act?

The Glass-Steagall Act of 1933 forced commercial banks to refrain from investment banking activities to protect depositors from potential losses through stock speculation. Glass-Steagall aimed to prevent a repeat of the 1929 stock market crash and the wave of commercial bank failures.

Signed into law by President Franklin Delano Roosevelt on June 16, 1933, the Act was part of the New Deal and became a permanent measure in 1945. Glass-Steagall was repealed in 1999, although some provisions remain, including the Federal Deposit Insurance Corporation (FDIC), which guarantees individual deposits.

Provisions of the Glass-Steagall Act

In the pre-Depression era, banks often diverted funds and took risks on speculative investments. The Glass-Steagall Act of 1933 created a regulatory firewall between commercial and investment bank activities. The legislation is named for Senator Carter Glass, a former Treasury secretary and the founder of the United States Federal Reserve System, and Henry Bascom Steagall, a former member of the House of Representatives and chair of the House Banking and Currency Committee. Its provisions include:

• Banks were forced to choose between specializing in commercial or investment banking. Ten percent of a commercial bank's total income could stem from securities; however, an exception allowed commercial banks to underwrite government-issued bonds.
• An amendment to the Act created the Federal Deposit Insurance Corporation (FDIC).
• The law enabled the Federal Reserve to regulate retail banks,
• Glass-Steagall introduced the Federal Open Market Committee and, ultimately, monetary policy.
• The law encourages banks to use their funds for lending rather than investing those funds in the equity markets.

Effects on the Banking Sector

Financial giants such as JP Morgan and Company were directly targeted by the legislation and forced to cut their services and source of their income. By creating this barrier, the Glass-Steagall Act aimed to prevent the banks' use of deposits for speculation and prevent failed underwriting.

An extension of the Glass-Steagall Act, the Bank Holding Company Act of 1956 defined a bank holding company as any company with a stake in 25 percent or more of the shares of two or more banks. The Glass-Steagall Act provided for their regulation. By the mid-1950s, bank holding companies had surfaced to avoid the restrictions on bank branching or banks with multiple offices. The 1956 legislation allowed Congress to give the Federal Reserve more oversight.

The 1999 Repeal and the Gramm-Leach-Bliley Act

The limitations imposed on the banking sector by the Glass-Steagall Act sparked debate over how restrictions are imposed. Many argue that banks that diversify their activities reduce risk to consumers. Some economists believe the law stifled the commercial banking sector until its repeal and prevented economic growth. Others believe that it prevented market volatility and aided the prosperity of the post-war years.

In 1999, Congress partially repealed the Glass-Steagall Act. The establishment of the Gramm-Leach-Bliley Act, or the Financial Services Modernization Act, eliminated the Glass-Steagall Act's restrictions against affiliations between commercial and investment banks. The Federal Deposit Insurance Corporation (FDIC) was not disabled during the repeal of Glass-Steagall.

Financial Crisis After Repeal

Many economists believe that speculative and risky activities followed the repeal of Glass-Steagall, including the rise in subprime lending, which led to the 2008 financial crisis. Proponents of the repeal argue that the Glass-Steagall Act was a minor contributor to the financial crisis. Instead, they claim that at the heart of the 2008 crisis was nearly $5 trillion worth of worthless mortgage loans, among other factors.

The repeal of Glass-Steagall was at issue during U.S. Senate Finance Committee hearings after the collapse of Silicon Valley Bank. The 16th largest U.S. bank failed in March 2023 after heavily relying on insured deposits for investment, and the massive withdrawal of deposits led to liquidity problems. The Federal Reserve intervened following the collapse to improve confidence in the banking system and prevent future failures. This included establishing the Bank Term Funding Program (BTFP), a lending program aimed at providing emergency liquidity to U.S. depository institutions. BTFP will cease making loans on March 11, 2024.

The Bottom Line

The Glass-Steagall Act prevented commercial banks from speculative risk-taking to avoid a financial crisis experienced during the Great Depression. Banks were limited to earning 10% of their income from investments. The regulation was met with criticism and was repealed in 1999 under President Clinton.