1933 Banking Act Pros And Cons

The 1933 Banking Act, also known as the Glass-Steagall Act in reference to the legislation’s sponsors Carter Glass and Henry B. Steagall, was a statue enacted by the 73rd United States Congress which created the Federal Deposit Insurance Corporation (FDIC) and separated investment banking from commercial banking. The act established clear delimitations between commercial and investment banks, and made it illegal for them to operate in conjunction. Federal Reserve member banks were banned from dealing in non-governmental securities for customers, underwriting or distributing non-governmental securities, investing in non-investment grade securities for themselves, and affiliating with companies involved in such activities. Concurrently, investment banks were prohibited from accepting deposits.

Banks were given one year after the law’s passage to determine whether they would engage in commercial or investment banking.
The Glass-Steagall act came into existence amid the worst economic downturn in US history, the Great Depression. In 1933, unemployment was at 25% and the banking industry had literally collapsed. More than 10, 000 banks had failed or merged, a reduction of 40% in the total number of these institutions. Confidence in the ability of banks to pay their debts had evaporated and everybody was rushing to try to take out their money, which exacerbated the already chaotic situation, leaving the banks without the liquidity needed to continue their operations. Several state banks were shut down, and by March of 1933 President Roosevelt had closed all the banks (“Understanding How”, 1998).
The purpose of creating the FDIC to insure consumers’ deposits with commercial banks was to avoid bank runs by giving depositors the assurance that their money would be secured by the government.

Consequently, the provisions to separate commercial banking from securities and investment firms were regarded as a way to diminish the risk associated with providing such deposit insurance. Although some historians argue that the depression itself is what caused the collapse of the banking system, in 1933 the general consensus was that banks had provoked the failure by engaging in shady and abusive practices with depositor’s money. Congressional hearings conducted in early 1933 seemed to indicate that bankers and brokers were guilty of “disreputable and seemingly dishonest dealings, and gross misuses of the public's trust” (“Understanding How”, 1998). The Glass Steagall act was the main legislative response of President Roosevelt’s administration to the unprecedented financial turmoil that was facing the nation in the middle of a deep depression. It was intended to regulate and stabilize the banking industry, reduce risk, and provide consumers with confidence in the financial

system.
Despite the statue’s clear provisions separating commercial and investment banking, it contained some big loopholes that undermined its effectiveness over time. The restrictions set by this bill did not apply to either S&Ls or to state-chartered banks that were not associated with the Federal Reserve. Also, securities firms were not prohibited from owning such institutions. Although a bank that was member of the Federal Reserve was not allowed to deal directly with none government-issued securities, such a bank was permitted to affiliate with a company so long as that company was not “engaged principally” in such activities. Starting in the 1960s, securities and S&L firms began to take advantage of these loopholes to create affiliates that engaged in commercial banking practices. By 1987, the lines drawn to delimit the boundaries between commercial and investment banking had been notably blurred, as the Federal Reserve board decided that the “engaged principally” clause meant that a member bank could affiliate with a securities institutions as long as such firms were not primarily dedicated to dealing with the securities practices banned by section 16 of the Glass-Steagall Act. This broad interpretation allowed Citigroup to acquire Salomon Smith Barney, one of the world’s largest securities firms. Then, in 1998, Citigroup also acquired an insurance company called Travelers Group, a move that violated both the Glass Steagall restrictions and the Bank Holding Company Act of 1956. However, the Federal Reserve gave them a temporary waiver, assuming that the law would soon be modified.
That change indeed occurred in 1999, when President Bill Clinton signed the Gramm-Leach-Bliley Act, a bill passed by Congress to modernize the financial industry. It effectively repealed the main provisions of the Glass-Steagall Act and allowed commercial banks to merge with investment and insurance companies. The new law also “repealed Glass–Steagall's conflict of interest prohibitions "against simultaneous service by any officer, director, or employee of a securities firm as an officer, director, or employee of any member bank," and diminished the Securities and Exchange Commission’s ability to regulate large investment bank holding companies (Payson, 2014). The argument presented in favor of this legislation was that the Glass Steagall provisions were no longer effective or necessary, and that allowing banks to diversify their services would result in more convenient and inexpensive services offered to consumers.
Of the presidential candidates running for the democratic nomination in 2016, both Bernie Sanders and Martin O’Malley support enacting a modern version of Glass Steagall and breaking up the so-called “too big to fail” banks. On the other hand, Hillary Clinton has downplayed the role that the repeal of Glass Steagall played in the events that lead to the Great Recession, and dismissed the idea of reinstating it. Alternatively, she’d laid out a plan to reform Wall Street which according to her is more “comprehensive” (Qiu, 2015). Similarly, none of the Republican candidates have called for bringing back Glass Steagall. Instead, what they want is further deregulation of Wall Street, as all of them oppose the Dodd–Frank Act, Congress’s regulatory response to the Great Recession.
I agree with Senator Sander’s position on the reinstatement of Glass Steagall as part of a comprehensive effort to reform Wall Street. After the passage of the Glass Steagall Act, the United States experienced a long period of financial stability which prolonged for over 60 years without major financial crises. Conversely, less than a decade after its repeal, that period of stability came to an abrupt end. Although the role that the Glass Steagall repeal played in the crises of 2007 is disputed by economists, many experts agree that it contributed to the crash at least partially. Nobel laureate Joseph Stiglitz thinks that the overturn of the Glass-Steagall provisions was as a major factor in the financial crises. By bringing "investment and commercial banks together, the investment bank culture came out on top," Stiglitz wrote in 2009. "There was a demand for the kind of high returns that could be obtained only through high leverage and big risk-taking” (Zarroli, 2015).
Furthermore, permitting commercial banks to merge with investment and insurance firms allowed these institutions to consolidate and grow even bigger, increasing the problem of “too big to fail” banks and a “culture of excess, big bonuses and poor decision making.” When the crisis hit, the government was forced to intervene and bail out the big banks that were on the brink of collapse, because letting them fail could have caused the entire system to tumble down like a house of cards. It is true, though, that Glass Steagall would not have directly prevented the problems of firms like Bear Stearns, Lehman Brothers, Merrill Lynch, and AIG, which did not conduct commercial banking activities prior to the crash. However, Robert Reich, former Secretary of Labor under President Clinton, argues that “the 2008 financial crisis became a systemic threat specifically because too-big-to-fail banks were underwriting the risky bets these companies made,” which they were now allowed to do because Glass-Steagall had been repealed (Eskow, 2015). Additionally, former Federal Reserve Chairman Ben Bernanke, who is not a supporter of Glass Steagall, admitted that it could have prevented the failure of at least one major financial institution: Citigroup (Gass, 2015).
Banks should not be allowed to gamble with people’s money by engaging in high risk speculative transactions. Besides, just because this legislation by itself wouldn’t have prevented all the problems that provoked the crash, is not a good enough argument to say that it’s not necessary at all. In like manner, I think the correct approach in 1999 would have been to fix the flaws in the law that allowed banks to go around it, not to get rid of the regulations altogether. Reinstating a modern version of Glass Steagall that closes the loopholes of its predecessor is a way to reduce the risk of another collapse in the financial markets, and should not be dismissed just because it wouldn’t fix every problem with the system.
Moreover, the issue of “too big to fail” banks in not a thing of the past. In fact, the top financial institutions are now larger than they were prior to the recession. According to data from the Federal Reserve, the five biggest banks in the United States today own assets totaling about $6.9 trillion, which is equivalent to 45% of the industry’s total assets. This massive concentration of wealth exacerbates the problem of moral hazard, as these mega banks are not incentivized to avoid reckless behavior that involves excessive risk because they know they are so big the government has no option but to come to their rescue when their dubious practices cause another crisis. Besides, this huge accumulation of wealth and power in the hands of a few financial institutions is not only economically unsound, but it’s also undermining our democracy. Thanks to the Supreme Court’s ruling in the “Citizens United” case, private corporations are allowed to inject unlimited amounts of money into the political process to help elect politicians that will do their bidding once in power, to the extent of even passing legislation drafted by lobbyists for the banking industry. Although this absurd level of “legalized corruption” will not be solved unless the campaign financed system is reformed, breaking up the “too big to fail” banks would be a good first step in the right direction.
As Senator Sanders suggests, if a bank is too big to fail, “it is too big to exist” (Miedema, 2015). Therefore, a modern version of Glass Steagall should be enacted to once again separate commercial banking from investment and insurance firms, and also to break up those institutions that are still “too big”, even after the separation of investment and commercial activities. The legislation should also include provisions that were not present in the old version of Glass Steagall, to reduce the kind of speculative transactions that lead to the 2007 crises. The combination of such measures could provide more stability to the financial system and help avoid another massive fiasco.