With the 2016 presidential primary season gathering steam, candidates on both sides continue to debate a banking law passed in the middle of the Great Depression.
The Glass-Steagall Act, whose partial repeal in 1999 has been blamed by some for the financial crisis of 2008-09, had imposed a regulatory separation between traditional banking and higher-risk investing activities.
Democratic presidential front-runner Hillary Clinton says she would not reinstate the banking law but has instead laid out a multipronged plan to mitigate risk in the financial industry, including so-called shadow banking, which, she says, played a greater role in the crisis than the commercial banks covered by Glass-Steagall.
Clinton’s leading opponent for the Democratic nomination, Sen. Bernie Sanders of Vermont, would fully reinstate the law, and a 2015 bill to that end has the support of politicians from all corners of the political spectrum. Also among those in favor: two Republicans, former candidate and Arkansas Gov. Mike Huckabee and retired neurosurgeon Ben Carson.
Also on the Republican side, former Florida Gov. Jeb Bush says he’s “open to the idea” of reinstating Glass-Steagall, but, like Sen. Marco Rubio of Florida, Sen. Ted Cruz of Texas and businessman Donald Trump, he has called for the repeal of Dodd-Frank legislation, which includes a rule some have called “Glass-Steagall light.”
Read on for more about:
- The original Glass-Steagall Act.
- Its repeal and the subsequent financial crisis.
- Its partial reinstatement as the Volcker Rule in 2010.
- The congressional proposal to fully reinstate it.
How we got here
Glass-Steagall and the Banking Act of 1933: The Glass-Steagall Act is actually a set of provisions included in the broader Banking Act of 1933, a response to the bank failures of the Great Depression. The Banking Act created the Federal Deposit Insurance Corp. to safeguard consumers’ deposits at commercial banks and included the Glass-Steagall provisions to reduce the risk of providing such insurance.
Most critically, Glass-Steagall made it illegal for a bank that held FDIC-insured deposits to invest in anything other than government bonds and similarly low-risk vehicles. Joseph Stiglitz, winner of a Nobel Prize in economics and a professor at Columbia University, wrote in a 2008 opinion piece:
“Commercial banks are not supposed to be high-risk ventures; they are supposed to manage other people’s money very conservatively. It is with this understanding that the government agrees to pick up the tab should they fail. Investment banks, on the other hand, have traditionally managed rich people’s money — people who can take bigger risks in order to get bigger returns.”
Glass-Steagall attempted to keep commercial banks low-risk to make it safer for the government to back those banks with deposit insurance, which would, in turn, prevent another Great Depression.
The partial repeal of Glass-Steagall and the financial crisis: After decades of lobbying and proposed legislation, some of the Glass-Steagall provisions were repealed in 1999, when the Gramm-Leach-Bliley Act was signed. Glass-Steagall’s opponents had objected to what they perceived as over-regulation of the banking industry.
Some critics believe Glass-Steagall’s partial repeal contributed to the 2008-09 financial crisis, alongside earlier weakening of the act’s effects through various government actions. Even John S. Reed and Sandy Weill, the former co-chairmen of Citigroup — created in 1998 as the acquisition of an investment bank, Salomon Smith Barney, by a commercial bank, Citibank — have both said, in effect, that Glass-Steagall protected the U.S. economy.
Others, including economists Paul Krugman and Mike Konczal, have argued that Glass-Steagall would have done nothing to prevent the financial crisis, because it didn’t cover the shadow banks that had engaged in the riskiest behavior.
The Volcker Rule, or “Glass-Steagall light”: Pursuant to the view that the 2008-09 crisis resulted in part from a lack of sufficient separation, post-Glass-Steagall, between investment and commercial banking activities, Congress included the Volcker Rule in the Dodd-Frank reform legislation, signed into law by President Obama in 2010.
The part of Glass-Steagall known as Section 16, which was not repealed, limits the kinds of investments banks can make with customers’ deposit funds. Section 20, which was repealed, limited what banks could do even with their own money. The Volcker Rule reinstated some of the prohibitions of Section 20.
The future of Glass-Steagall
Potential issues with Volcker, including loopholes and gray areas that may impede enforcement, led to the introduction of the 21st Century Glass-Steagall Act. Four U.S. senators introduced the bill in July seeking to revive the broader banking law.
Sens. Elizabeth Warren, D-Mass., and John McCain, R-Ariz., among others, introduced the act. In McCain’s words, the act aims to “rebuild the wall between commercial and investment banking that was in place for over 60 years, restore confidence in the system, and reduce risk for the American taxpayer.”
The fate of the legislation, and of financial regulation in generally, will likely hinge on the results of the 2016 election.
Although Clinton’s plan to address the issues doesn’t include a full reinstatement of Glass-Steagall’s provisions, as Sanders’ does, Clinton would:
- close one of the Volcker rule’s biggest loopholes, involving hedge-fund investing
- instate risk fees on large financial institutions engaged in certain activities
- increase the government’s regulatory power over “shadow banks” such as Lehman Brothers, whose role in the financial crisis is widely accepted even by those who don’t believe Glass-Steagall’s partial repeal was a factor
On the other side of the aisle, apart from supporting the repeal of Dodd-Frank — including the Volcker rule — most candidates have said they would sign into law the REINS Act (for “Regulations From the Executive in Need of Scrutiny”). The act, sponsored by former GOP presidential candidate Sen. Rand Paul of Kentucky, would require major regulations issued by federal agencies in the executive branch to be subject to congressional approval.
Importantly, REINS would not be retroactive as a law, and the banking regulations opposed by the act’s supporters were not agency-issued, but congressional legislation. Still, the REINS Act would meaningfully inhibit the power of agencies to issue new regulations across economic sectors.
Apart from Paul, Cruz and Rubio are listed as co-sponsors, and all three, along with Bush and Trump, have said they would sign the bill.
The bottom line
Despite its complexity, regulation of the financial sector will likely remain one of the most hotly debated issues of the 2016 presidential race. Depending on the state of the economy heading into summer, the issue may play a strong role in deciding the election.
This post was updated. It was originally published on June 11, 2012.