The Republican party platform calls for a revival of the Glass-Steagall Act, a depression-era banking law repealed in 1999. So what was Glass-Steagall?
Glass-Steagall was the brainchild of Sen. Carter Glass (D-VA), best known as the principal architect of the Federal Reserve system. It erected a firewall between deposit-taking/loan-making banks and securities activities such as underwriting and trading. Its original goal was to prevent three things: purchasing of risky securities with government-insured deposits, extending bad loans to shaky companies owned by a bank, and pushing underwritten securities onto naïve bank customers.
The provision became law when the Banking Act of 1933 was passed within days of President Franklin Roosevelt taking office in March 1933 in an effort to restore public confidence in the banking system. The same act created the Federal Deposit Insurance Corp., which insures bank deposits, as well as the Federal Open Market Committee, the monetary policy making board of the Federal Reserve. The act also banned banks from paying interest on checking accounts and granted the Fed authority to put ceilings on interest rates offered for other deposits.
Far from resisting Glass-Steagall, Wall Street securities firms embraced and became its most vocal supporters. The law was seen as protecting the specialized securities firms from having to compete with large national banks funded by cheap retail and commercial deposits. The law was strengthened by a 1956 law that put bank holding companies under the purview of the Federal Reserve and made it clear they could not control both a commercial bank and an investment bank.
As the years passed, however, the wall separating securities firms and banks developed cracks—primarily because of pressure from banks wanting to expand into securities dealing. Banks won regulatory approval for their affiliates to underwrite government securities, mortgage-backed securities and commercial paper. They were allowed to provide brokerage services to customers and market insurance. Banks began providing advice and assistance on mergers, acquisitions and financial planning. All this occurred without the law being changed.
Meanwhile, developments outside the regulated banking system all chipped away at the Glass-Steagall edifice. Households and businesses moved money out of deposits and into money market funds. Underwriting for short-term financing for business was increasingly dominated by securities firms. Regulators worried that banks—and therefore bank regulators—were being marginalized by loosely regulated “shadow banks.”
As early as 1988, William Isaac, a former chairman of the FDIC, wrote a law review article arguing that “confining banks to a narrow range of products and services of declining profitability, Glass-Steagall threatens the long-term health and survival of banks as the fulcrum of our regulatory system.” Glass-Steagall was part of “a dying breed” of outdated financial regulation, Mr. Isaac wrote.
Glass-Steagall managed to live for another decade after Mr. Isaac’s article, in part because the “Black Monday” stock market crash of October 19, 1987 caused many to worry anew about the stability of securities markets. Ironically, some of these fears were stoked by the securities industry, according to Mr. Isaac’s article. Then Fed chairman Alan Greenspan was prompted to urge congress to proceed with the repeal despite Black Monday. But time and again, commercial banks were out-maneuvered on Capitol Hill by the securities industry.
By the time Glass-Steagall was repealed in 1999, banks were already engaged in securities underwriting and brokerage services, while securities firms were doing many of the things banks had traditionally handled, such as managing consumer savings and funding business expansions. Many regulators agreed with Congressman Jim Leach (R-IA) that the law needed to be scrapped because it no longer mapped reality.
The push for repeal, tellingly, came from commercial banks. For the most part, securities firms—which didn’t have much interest in commercial banking but definitely wanted to keep commercial banks out of their turf—resisted, including successfully killing attempts in 1987 and 1988 to end the Glass-Steagall firewalls. They eventually capitulated in the late 1990s—but only after winning concessions that firms like Goldman Sachs and Merrill Lynch believed would protect them from unfair competition with FDIC insured banks.