Glass Steagall Act: Definition, Purpose, and Repeal

This 1933 Law Would Have Prevented the Financial Crisis

Glass Steagall protects deposits during bank failures.
Security guards open the door for Nasim Ahmed and his one-year-old daughter Roed as hundreds of nervous customers wait in line to get into an IndyMac Bank, open for the first time since the July 11 federal government takeover of the thrift, on July 14, 2008 in Pasadena, California.. Photo by David McNew/Getty Images

Definition: The Glass-Steagall Act is a law that prevented banks from using depositors' funds for risky investments, such as the stock market. It was also known as the Banking Act of 1933 (48 Stat. 162). It gave power to the Federal Reserve to regulate retail banks. It also prohibited bank sales of securities. It created the Federal Deposit Insurance Corporation (FDIC).

Glass-Steagall separated investment banking from retail banking.

Investment banks organize the initial sales of stocks, called an Initial Public Offering. They facilitate mergers and acquisitions. Many of them operated their own hedge funds. Retail banks take deposits, manage checking accounts and make loans.

When Was It Passed?

Glass-Steagall was passed by the House of Representatives on May 23, 1933. It was passed by the Senate on May 25, 1933. It was signed into law by President Roosevelt on June 16, 1933. It was originally part of his New Deal . It became a permanent measure in 1945. (Source: Glass-Steagall 1933, The New York Times.)

What Was the Purpose of Glass-Steagall?

Glass-Steagall was enacted as an emergency response to the failure of nearly 5,000 banks during the Great Depression. In 1933, all U.S. banks closed for four days. When they reopened, they only gave depositors 10 cents for each dollar. Where did the money go? Many banks had invested in the stock market, which crashed in 1929.

When depositors' found out, they all rushed to their banks to withdraw their deposits.

Even sound banks usually only keep one tenth of the deposits on hand. They will lend out the rest because they know that normally that's all they need to keep on hand to keep their depositors' happy. However, in a bank run, they must quickly find the cash.Today, we don't have to worry about bank runs because the FDIC insures all deposits.

Since people know they will get their money back, they don't panic and create a bank run.

Repeal of Glass-Steagall

Glass-Steagall was repealed in 1999 by the Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act was passed along party lines by a Republican vote in the Senate.The banking industry had lobbied for the repeal of Glass-Steagall since the 1980s. They complained they couldn't compete with other securities firms. The banks said they would only go into low risk securities. They wanted to reduce the risk for their customers by diversifying their business.

The repeal of Glass-Steagall consolidated investment and retail banks. That led to banks becoming too big to fail. This required their bailout in 2008-2009 to avoid another depression.

Should Glass-Steagall Be Reinstated?

Congressional efforts to reinstate Glass-Steagall have not been successful. In 2011, H.R. 1489 was introduced to repeal the Gramm-Leach-Bliley Act and reinstate Glass-Steagall. If these efforts were successful, it would result in a massive reorganization of the banking industry.

The largest banks include commercial banks with investment banking divisions, such as Citibank, and investment banks with commercial banking divisions, such as Goldman Sachs. 

A reinstatement of Glass-Steagall would better protect depositors. At the same time, it would create organizational disruption in the banking industry.  This might be a good thing, as these banks would no longer be too big to fail, but it should be managed effectively.

The banks argued that reinstating Glass-Steagall would make them too small to compete on a global scale. The Dodd-Frank Wall Street Reform Act was passed instead. 

A part of the Act, known as Volcker Rule, puts restrictions on banks' ability to use depositors' funds for risky investments. It does not require them to change their organizational structure. If a bank becomes too big to fail and threatens the U.S. economy, Dodd-Frank requires that it be regulated more closely by the Federal Reserve. Article updated January 18, 2016.

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