What was the Glass-Steagall Act?
The Glass-Steagall Act was a piece of financial legislation that dates to the Great Depression. It was part of a broader set of regulations, known as the Banking Act of 1933, that moved to restore confidence in the banking system after thousands of bank failures in the first years of the Depression.
The provisions prohibited banks from investing in risky securities, though they could invest in government bonds. The legislation was designed to lower the risk of failure in commercial banks and help safeguard customer accounts.
The Banking Act of 1933 also created the Federal Deposit Insurance Corporation to provide deposit insurance for banks and help prevent another Depression. Glass-Steagall helped reduce the risk to the government for providing this insurance.
»Read more: How does FDIC insurance really work?
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Glass-Steagall repeal
Over time, politicians and economists critical of the prohibitions advocated ending Glass-Steagall. They objected to what they perceived as over-regulation of the banking industry.
In 1999, after decades of lobbying and proposed legislation, some Glass-Steagall provisions were repealed as part of the Gramm-Leach-Bliley Act. Institutions could participate in both commercial and investment activities.
But critics of the repeal said it crossed a firewall between commercial and investment banking, and may have led to the Great Recession of 2008. Joseph Stiglitz, winner of a Nobel Prize in economics and a professor at Columbia University, wrote in a 2009 Vanity Fair 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.”
Others have argued that Glass-Steagall would have done nothing to prevent the financial crisis because it didn’t cover the pure investment houses or institutions whose risky loan behaviors most directly underwrote the crisis. In other words, the recession was unavoidable for banks and their customers.
»Learn more: How to grow your savings in good times and bad
The Volcker Rule
In the aftermath of the banking crisis, Congress restored some of the spirit of Glass-Steagall with the Volcker Rule, which was part of the Dodd-Frank Act signed in to law in 2010.
Acting on the idea that the 2008-09 crisis resulted in part from a lack of sufficient separation between investment and commercial banking activities, the Volcker Rule limited banks’ ability to use customer deposits for speculative activity. The rule also limited bank ownership of hedge funds and private equity funds.
But the bank debate continues. In 2018, as part of a push to limit regulations, Dodd-Frank reforms were partially rolled back. Critics have sought to loosen Volcker Rule restrictions as well.
