The Banking Act of 1933, also known as the Glass-Steagall Act, was introduced as a response to the stock market crash of 1929. It established the Federal Deposit Insurance Corporation (FDIC) and enforced many other banking reforms. The congressional sponsors of this act were Senator Carter Glass, a Democrat from Virginia, and Representative Henry Steagall, a Democrat from Alabama. The Banking Act of 1933 combined two congressional projects: 1) the creation of a federal system of bank deposit insurance, and 2) the regulation of commercial and investment banking. Although at the time, the Roosevelt administration and many in Congress resisted and criticized the act for introducing inefficiency and limiting competition, today many of its supporters consider the act to be the possible explanation for a long period of financial stability in U.S. banking history.
Contrary to the commercial banking theory prevalent during the 1920s, many economists and politicians argue that the stock market crash of 1929 happened mainly because banks were loosely regulated and were actively involved in security market speculation. Following its inception in 1913, the Federal Reserve System had minimal control over the activities of U.S. commercial banks. Senator Glass was one of the proponents of the commercial banking theory, which suggests that commercial banks should limit their lending to short-term loans to finance only the production and sale of goods (versus securities such as stocks or bonds) in commercial transactions. Glass believed that if this theory had been followed and enforced, the crash of 1929 could have been avoided. Senator Glass introduced his first bill on June 17, 1930, to investigate the operations of the National and Federal Reserve banking systems.
Furthermore, Glass and his long-term adviser Henry Willis opposed the engagement of commercial banks in real estate lending, a practice that decades later crippled the U.S. economy during the recession of 2007–2009. Glass criticized banks for lending to stock market speculators and for engaging in risky security transactions, and criticized the Federal Reserve for not applying better regulatory policy.
In 1933, Senator Carter Glass and Representative Henry Steagall introduced the Banking or Glass-Steagall Act. The main purpose of this historic legislation was to limit conflicts of interest between the banks and individual investors caused by the involvement of commercial banks in underwriting activities related to the security exchange. The new law prohibited commercial banks from underwriting securities. In addition, the banks had to choose between being a commercial or an investment bank. The Glass-Steagall Act also introduced the Federal Deposit Insurance Corporation (FDIC) to insure deposits of all commercial banks and to increase the control of the Federal Reserve over them. The deposit insurance and most provisions of the act were severely attacked during congressional debate, mainly for limiting competition and introducing inefficiency into the U.S. banking industry. Despite all opposition, the Banking Act of 1933 was signed into law by President Roosevelt on June 16, 1933.
The law imposed numerous banking reforms and established the FDIC in the U.S. banking system. The Banking Act of 1933 had a significant number of provisions, many of which were changed or repealed over time. The provision that required all FDIC-insured banks to be members of the Federal Reserve System was repealed in 1939. In 1956, the Bank Holding Company Act extended banking regulations by restricting banks that owned other banks from engaging in nonbanking activities or acquiring banks in other states. During the 1960s and 1970s, bank lobbyists persuaded Congress to allow commercial banks to enter the securities market. By the 1970s, a number of investment firms started introducing some of the traditional commercial banking services, offering services such as money market accounts with interest, allowing check writing, and offering credit or debit cards.
In 1986, the Federal Reserve Board bent the law by allowing commercial banks to earn up to 5 percent of their gross revenue from investment banking. Later, the Federal Reserve Board allowed the Banker Trust, a commercial bank, to actively participate in short-term credit transactions and underwriting activities. Finally, in 1987, after more than five decades of strong lobbying of big commercial and investment firms against the Banking Act of 1933, the Federal Reserve Board voted three to two in favor of easing the restrictions imposed by the act. In March 1987, despite strong opposition from Paul Volcker, the Federal Reserve Board chair at the time, the Fed approved an application by Chase Manhattan to participate in underwriting securities. In addition, the Fed increased the limit for participation of commercial banks in securities investment from 5 percent to 10 percent of their gross revenue.
In August 1987, Alan Greenspan became the new chair of the Federal Reserve Board of Governors. A former director of J. P. Morgan, Greenspan firmly advocated for banking deregulation. In 1989, the Federal Board approved additional applications by J. P. Morgan, Chase Manhattan, and other national banks to allow them to expand their transactions to debt and equity securities. In 1990, J. P. Morgan became the first bank to participate in underwriting activities, with the condition that it not exceed the newly imposed 10 percent limits. After the Senate's numerous failed attempts to repeal the Glass-Steagall Act of 1933, in December 1996, supported by Chairman Alan Greenspan, the Federal Reserve Board increased the limit for engaging in securities business to 25 percent of the gross revenue of commercial banks. Finally, in 1999, Congress passed the Financial Services Modernization Act, repealing the Banking Act of 1933.
See Also Federal Deposit Insurance Corporation (FDIC); Federal Reserve System; Great Depression (1929–1939); Greenspan, Alan; Roosevelt, Franklin Delano; Volcker, Paul
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