The Glass-Steagall Banking Act of 1933 was legislation that effectively separated the commercial banking industry from investment banking. It created the FDIC (Federal Deposit Insurance Corporation) and provided other consumer benefits. At the time it was signed into law, it was one of the most hotly debated initiatives of the Roosevelt Administration.
What many people don’t realize about the Glass-Steagall Banking Act of 1933 was that it was considered an emergency law. It was passed within days of FDR taking office, working to create safer and more effective use of bank assets to prevent undue diversion into speculative operations. The goal was to direct bank credit into “more productive” uses than speculation, such as agricultural, commerce, or industry.
The law also had a significant impact on the Federal Reserve, creating the FOMC (Federal Open Market Committee). Revisions in 1935 and 1942 helped to bring it closer to what it is today.
List of the Pros of the Glass-Steagall Banking Act of 1933
1. It created restrictions on borrowing from bank officers.
Before the passage of the Glass-Steagall Banking Act of 1933, there were no restrictions in the United States on the right of a bank office of a member institution to borrow from the business. Excessive loans to directors and officers were of grave concern to regulators at the time, so legislators enacted a provision that prohibited lending products to any executive officers. The law also required any outstanding loans to be paid back in full to be in compliance with the regulation.
2. The legislation helped to create deposit insurance in the United States.
An essential provision of the Glass-Steagall Banking Act of 1933 was the creation of the FDIC. This corporation insures bank deposits with a pool of money collected from these financial institutions. It was such a controversial idea at the time that FDR threatened to veto the new law if it was included in the measure. Large banks opposed the idea because they felt like it would cause them to be subsidizing smaller institutions. Past attempts by the states to create something similar had already failed.
It turned out to be a successful venture. The initial fund helped to insure deposits of up to $2,500. The limit was raised to $5,000 a few months later, and it has continued to rise to the $250,000 level it is today.
3. The act improved the regulation and oversight of national banks.
The Glass-Steagall Banking Act of 1933 provided tighter regulations of national banks to the Federal Reserve System. It required holding companies or affiliates of state member banks to create three annual reports to their board and bank. Any bank holding companies that owned a majority of shares I any other Federal Reserve member institution had to register with the government to obtain a permit to vote their shares.
This oversight helped to correct some of the speculation and risk that eventually led to the Great Depression. It gave people more control over their money because it added another layer of transparency to the financial systems in the United States.
4. It limited the structure of income and assets for banks.
After the passage of the Glass-Steagall Banking Act of 1933, only 10% of a commercial bank’s total income could come from securities. The only exception to this rule was an allowance to underwrite government-issued bonds. Institutions were given a year to decide if they wanted to specialize in investment or commercial banking, and then the rules of the new law were enforced on each business. At the time of its passage, there was broad relief because Americans felt like it would eventually lead them toward a healthier financial system.
This advantage remained in place until the Gramm-Leach-Bliley Act of 1999 that repealed provisions of the law that restricted affiliations between securities firms and banks.
5. The legislation stopped overlapping directorships and common ownership problems.
The primary provisions of the Glass-Steagall Banking Act of 1933 separated investment banking from its investment sibling. Any institution that took in deposits or made loans were no longer permitted to deal in or underwrite securities. Investment banks, who dealt in or underwrote securities, no longer had permission to have close contacts with commercial banks. That included common ownership structures and overlapping directorships.
6. It gave the Federal Reserve the right to regulate retail banks.
Up until the implementation of the Glass-Steagall Banking Act of 1933, the Federal Reserve had no authority to regulate retail banks. That all changed in 1934 when the provisions of this law became active. By creating the FOMC, it allowed the Fed to implement monetary policies that were better equipped to help the economy as a whole. That meant the accounts of depositors would receive greater protection because the institutions had to find another source of funds that was separate from this money.
7. The legislation helped to build a financial reserve into the system.
Between 1922 and the 1929 crash, the stock market had been going up at a rate of 20% per year. Banks were investing in stocks because the returns were massive. It’s the reason why the interest rates were so competitive for consumers at the time. Since the funds from these accounts could be used for those investments, depositors rushed to withdraw their money immediately when the bottom fell out of the market.
Over $1.78 billion was removed from the U.S. banking industry in just four weeks because of what happened in the stock market. Some people demanded gold when cash wasn’t available since the country was still on the gold standard. Demands were so high that even the Federal Reserve ran low on deposits. The Glass-Steagall Banking Act of 1933 helped to build reserves into the system so that a bank run wouldn’t be as devastating.
8. It worked to eliminate issues with conflicts of interest in the banking sector.
Ferdinand Pecora is the man often given credit for uncovering the actions of banking officers and executives with his investigation into the industry. He was serving as Chief Counsel to the Senate’s Committee on Banking and Currency at the time. His investigation team revealed that banks could lend money to a company, and then issue stock in that same business, without revealing to shareholders the conflict of interest that existed.
Under the structure of the banking industry before the Glass-Steagall Banking Act of 1933, companies could fail without the bank suffering a loss from this structure. The investors in the bank, the business, or both would be the ones left responsible for any debts or losses in the aftermath of the issue.
9. The legislation stopped bank executives from a no-tax income scenario.
When Pecora started holding hearings about what was happening in the banking industry, the information that came out was shocking to most Americans. One of the biggest examples of the need for change with the eventual Glass-Steagall Banking Act came from Charles Mitchell, who headed the National City Bank (now Citibank) at the time. It was the largest institution in the United States.
Mitchell earned more than $1 million in bonuses in 1929 despite the stock market crash. He also didn’t pay any taxes on the amount. The testimony regarding National City Bank found that it took bad loan bundles, packaged them as securities, and then unloaded them on customers who didn’t realize where their money was going.
10. It stopped the idea of privilege being the primary source of wealth in the industry.
The problem with the banking sector was so bad that the American public began calling industry executives “banksters” because of their actions. Organized crime was problematic in many areas of the country at the time, so it was a play from the “gangster” label. The Chicago Tribune even wrote that the only difference between a burglar and the president of a bank was that one of them worked at night.
One of the top executives at Chase National Bank earned his wealth by short-selling company shares during the 1929 stock market crash. Financier J.P. Morgan issued stocks at discounted rates to a small circle of clients – including President Calvin Coolidge. By instituting this new series of laws, it removed the idea that privilege could buy you access to whatever you wanted. Banks had to use your money in safe ways to prevent losses from occurring.
List of the Cons of the Glass-Steagall Banking Act of 1933
1. It eliminated interest on checking accounts for consumers.
The Glass-Steagall Banking Act of 1933 introduced a provision that would become called Regulation Q in the future. It mandated that zero interest could be paid on consumer checking accounts. It also gave the Federal Reserve the authority to restrict the ceiling that banks could pay on other deposit types. The reason for this structure was that the reason for risky investments and speculation was an effort to compete for customers, leading to policies that eventually triggered the Great Depression.
The prohibition on interest-bearing demand accounts remained in place until the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010. Financial institutions are allowed, but not required, to provide interest once again.
2. It took a full year for the legislation to take effect across the country.
Legislators realized that banks would need some time to separate their commercial and investment businesses to be in compliance with the new law. That’s why institutions were given a full 12 months to decide which side of the industry they wanted to pursue. That delay certainly helped the institutions restructure themselves to continue providing services, but it also let them continue to combine resources during that entire time. This waiting period is arguably one of the reasons why the Great Depression continued to run unabated since the people had no initial control over its enforcement.
3. Passage of the legislation required a stoppage for the industry.
President Roosevelt was forced to declare a 4-day bank holiday starting on March 6, 1933, to ensure that the effects of the Glass-Steagall Banking Act could take effect as intended. Congress didn’t pass the Emergency Banking Act for another three days, which then meant banks couldn’t reopen again until March 13. Then they could no longer exchange dollars for gold, which meant the Federal Reserve would begin printing dollars to meet demand.
The currency was then based on the paper assets of the bank instead of something established by the gold standard. Most institutions found that the bank run was over on March 15, but that left a lot of families scrambling to manage their situation at home since they had little access to the accounts.
4. It slows the growth of the banking industry in the United States.
There is some talk about the reinstatement of the Glass-Steagall Banking Act because of the consumer protections the legislation provides. These efforts have not been successful because the law itself would slow the growth of the financial industry, including credit unions because they’d need to reorganize once again to meet the mandate of the legislation.
It would help because banks wouldn’t become “too big to fail,” which was a significant problem during the recession years of 2008 and 2009. That benefit would come at the expense of the economy, which would be less inviting to future investors.
5. The law doesn’t allow banks to compete on a global scale.
The idea of global banking was barely in its infancy when the Glass-Steagall Banking Act of 1933 was signed into law. Now that we live in a smaller place where information travels the world in seconds, having legislation like this in place would make it almost impossible for the American economy to remain competitive. Banks consistently argue that this law would force them into smaller positions that don’t allow them to be competitive with institutions operating in other countries.
A compromise from the Dodd-Frank Wall Street Reform Act is called the Volcker Rule. This point restricts the ability of a bank to use funds from depositors for anything deemed to be a “risky” investment. If the institution becomes too big to fail, threatening the overall economy, then the current legal structure requires that it be closely regulated by the Federal Reserve.
6. This legislation did not cover credit unions.
The Glass-Steagall Banking Act of 1933 only covered American banking institutions. Credit unions fell outside of the scope of this legislation. That meant another law had to be passed as part of the overall New Deal to cover depositors in these facilities. FDR would sign the Federal Credit Union Act into law in 1934 to allow for the chartering of these organizations in all states. The goal was to make credit more available to the average person through a national system of cooperative, non-profit opportunities instead of a patchwork of state-based systems.
This action eventually led to the creation of the NCUA, which is the credit union’s version of the FDIC. It also insures accounts valued up to $250,000 today. Regulatory responsibility for the credit unions has always shifted outside of the banking industry, eventually landing in the seat of the Department of Health, Education, and Welfare.
The Glass-Steagall Banking Act of 1933 was an essential first step toward economic recovery during the Great Depression. It was controversial at the time because of its inclusion of deposit insurance and the elimination of interest on certain accounts, but it was not a bill that got rushed through Congress. The House of Representatives passed its version of this act in 1932.
The overall impact of the legislation was that it worked to restore confidence in the American banking system. That trust could only occur because it forced banks to use the funds of depositors in safe investments. Then the creation of the FDIC helped to guarantee that future bank runs would be minimal because the government and this insurance could help to protect individuals from failing institutions.
The Federal Services Modernization Act in 1999 would officially repeal Glass-Steagall. The actions of Citigroup with Travelers Insurance forced the issue since the bank was taking advantage of loopholes that were technically illegal at the time. It passed along party lines but was signed by a democratic president.
Blog Post Author Credentials
Louise Gaille is the author of this post. She received her B.A. in Economics from the University of Washington. In addition to being a seasoned writer, Louise has almost a decade of experience in Banking and Finance. If you have any suggestions on how to make this post better, then go here to contact our team.