The Glass-Steagall Act, Explained

Glass-Steagall refers to four sections of the Banking Act of 1933, which were set to remedy the absolute power of the financial sector by creating a firewall between commercial and investment banking. Until the 1970s, Glass-Steagall was pretty much the law of the land. In theory, by taking Wall Street out of the equation, banks couldn’t invest in securities with their own assets, cutting down on conflicts of interest.

For example, the Glass Steagall Act was meant to prevent banks from providing loans that would bolster the prices of securities in which they have a stake. It was also supposed to cut back on the temptation for bank officials to persuade their customers to invest in ways that were self-serving to the banks but perilous to the customer — as in the case of Mr. Edgar Brown.

Not long after the stock market crash of 1929, the Senate Committee on Banking and Currency heard testimony from a number of Americans, including Edgar Brown. Brown was frail, old, deaf, and suffering from tuberculosis. The United States was coming off a five-year period of 25% unemployment, with approximately 4,000 commercial bank failures, which resulted in a $1.3 billion loss to depositors—approximately $18 billion in 2016 dollars. Brown represented the average American that had worked his whole life only to be swindled out of his savings by shady bankers.

According to the committee’s legendary counsel, Ferdinand Pecora, Brown was on the receiving end of a hard sell by the National City Company. Compelled to do so by the bank, Brown poured every last penny of his $100,000 nest egg into the bond and stock markets. Then the markets went belly up, and Brown lost everything.

“A bank was supposed to occupy a fiduciary relationship and to protect its clients, not lead them into dubious ventures; to offer sound, conservative financial advice, not a salesman’s puffing patter,” wrote Pecora in 1939. “The introduction and growth of the investment affiliate had corrupted the very heart of these old fashioned banking ethics.”

Hence, the Glass-Steagall Act. In the thralls of the Great Depression, Americans needed regulation if they were going to place their trust in banks again.  These were the days of gold hoarding, bartering, and stuffed mattresses. There was no faith in the national banks, which had been on the receiving end of bank runs and mergers, and had closed up shop in unprecedented numbers. But that distrust of banks didn’t last forever.

The Slow Demise of Glass-Steagall

Some say the dismissal of Federal Reserve Board Chairman Paul Volcker and the hiring of Alan Greenspan in 1987 symbolized the beginning of the end for Glass-Steagall, but the modernization of the financial industry, and the difficulty of staying competitive for federal banks, had chipped away at its efficacy for 20 years before Greenspan.

Court decisions started to soften the federal regulatory stance in the 1970s, and Glass-Steagall was partly repealed in 1999 by the Gramm-Leach-Bliley Act. Many cite the partial repeal of Glass-Steagall as a major factor leading up to the financial meltdown of 2007-08. Others question the correlation, noting the lack of combination banks on the list of bailed-out financial institutions.

Similarly, many argue that combination banks were not the root cause of the famous stock market crash of 1929, either — Carter Glass himself eventually had a change of heart and wanted to repeal Glass-Steagall. But what keeps the law relevant, whether or not it could have prevented the 1929 crash or the 2008-09 recession — is the overall sentiment: Many Americans feel banks are too big, and shouldn’t be able to gamble with our deposits.

In other words, when the babbling brook of commercial banking — where ordinary consumers park their savings and where small businesses get loans — merges with the whitewater rapids of investment banking, the failure risk will, at the very least, exacerbate an economic downturn, and at worst actually cause one.

The concern has continued as banks become even larger, despite measures put into place to regulate their growth after The Great Recession of 2008.

According to the World Bank, the current gross domestic product of the United States is approximately $18 trillion. The combined total assets of the 10 largest U.S. banks, meanwhile, is approximately $11.5 trillion. While economists in favor of an updated Glass-Steagall admit it isn’t surefire protection from a financial crisis, many believe the added regulation would help mitigate the “too-big-to-fail” dilemma.

“The biggest U.S. banks have become too big to manage, too big to regulate, and too big to jail,” argues Simon Johnson, former chief economist at the International Monetary Fund. “At a stroke, the proposed law would force global megabanks such as JPMorgan Chase and Bank of America to become smaller and much simpler—divorcing high-risk activities from plain-vanilla traditional banking. Their failures would no longer threaten to bring down the economy.”

Wall Street analysts see it differently, “There is not a single major failure that occurred because of the limited repeal of Glass-Steagall,” Rodgin Cohen, senior chairman of Sullivan & Cromwell, told CNBC. “So, to attribute the financial crisis [of 2008] to this limited amendment of Glass-Steagall, there’s just not a correlation.”

Either way, things are a lot more complicated — and bigger — than they were in 1929. Bank executives are richer than countries, technology is disruptive, and competition is fierce. JPMorgan Chase alone accounts for over $2.5 trillion in assets and, according to the Wall Street Journal, estimates $15 billion in annual earnings as a result of cross-selling between its commercial and investment entities, in addition to $3 billion saved in costs. A new Glass-Steagall Act would endanger that profit by separating those two units.

Bank of America, which acquired Merrill Lynch for $50 billion amid the fallout of the 2008 economic crisis, would take a hit with the introduction of a new Glass-Steagall Act as the two entities would be pried apart, not to mention Merrill Lynch itself, which would face the likes of Goldman Sachs without the backstop of BofA’s commercial banking wing.

Low interest rates and emerging technology—from Bitcoin and high-frequency trading to the proliferation of robo-advisors, online discount brokerages, money management apps, and other fintech startups — have disrupted the financial sector, leaving the behemoths of banking scrambling.

That’s not even touching on Wells Fargo, which would be forced to divest its mortgage banking activities. One look at Wells Fargo, recently fined $185 million for creating 2 million customer accounts without their consent — not to mention other alleged ethics violations and investigations of criminal misconduct — shows both the need for and the threat of further regulation: Tighter rules could lead to lower earnings, which could lead to desperate practices.

A recent report conducted on behalf of the Department of Homeland Security, shows the complexity of the situation. “The separation of commercial and investment banking can help insulate insured depositories from volatility in securities markets. It can also insulate investment decisions by depositors from conflicts of interest if depository bankers refer clients to their own affiliates. This insulation comes at the cost of reducing the diversification of revenue sources for the banking system.”

Could the Glass-Steagall Act Make a Comeback?

But what are the chances of a new Glass-Steagall actually coming to fruition? As recently as October, when President-elect Donald Trump called for a “21st-century” version of the act, chances looked pretty good.

From the campaign trail, a modern refresh of the Glass-Steagall Act seemed one of the few things some Republicans and Democrats actually agreed upon. Democratic Senator Elizabeth Warren of Massachusetts and Republican Senator and former presidential nominee John McCain of Arizona — along with Maria Cantwell (D-Wash.) and Angus King (I-Maine) — actually joined forces to sponsor a bill called the 21st Century Glass-Steagall Act in the summer of 2015.

And it’s not just the right and the left attempting to claim common ground on Glass-Steagall: It’s also a talking point from both free-market-focused and socially minded op-ed contributors.

In a recent opinion piece on Money Morning, Shah Gilani, editor of the Capital Wave Forecast, advocates taking Glass-Steagall one step further and calls Trump’s reboot of the regulatory act an “idea that has staying power.”

Money Morning recently published an opinion piece by Capitol Wave Forecast editor Shah Gilani that advocates taking Glass-Steagall one step further, and calls Trump’s reboot of the regulatory act an “idea that has staying power.” Meanwhile, an opinion piece by Nomi Prins for the Progressive calls for a similar charge to “break up the banks via a resurrected Glass-Steagall Act,” tax risky bank practices, and imprison CEOs who have broken the law.

Even American Banker ran an op-ed in support of Glass-Steagall, albeit by financial reform advocate Akshat Tewary.

Tewary, notably, doesn’t mention prison sentences for bankers in his piece, and you can draw your own conclusions as to the motive and reputability of any of these publications, but you get the drift: In the eyes of some very different interest groups, the fine points behind Glass-Steagall are nebulous, but the overall points are clear — and they ring reminiscent of those nearly decade-old platitudes against “too big to fail” banks and supporting “Main Street not Wall Street.”

In other words, according to Glass-Steagall advocates, bank failures shouldn’t bring down the entire American economy, and the American people shouldn’t be on the hook for their risky behavior.

But the question remains: Will the Glass-Steagall Act make a comeback? While the president-elect has expressed support for a 21st-century version of the law, his Cabinet and transition team are stocked with former Goldman Sachs executives and billionaire investors who would likely oppose such regulation– so it remains unclear whether we’ll see a realistic re-up of Glass-Steagall in the near future.