The Glass–Steagall legislation describes four provisions of the U.S.A Banking Act of 1933 separating commercial and investment banking. The article 1933 Banking Act describes the entire law, including the legislative history of the provisions covered here.
The Glass-Steagall Act also known as the Banking Act of 1933 was sponsored by two US senators, Carter Glass and Henry Steagall of the US congress in 1933, in the wake of the 1929 stock market crash. The objective of the Glass-Steagall Act was to separate commercial banking from investment banking. The Glass-Steagall Act was a collective reaction which was brought about to curb ‘improper banking activities’ or the involvement of commercial banks in stock market investment, which was considered to be the main cause of the financial crash at the time.
Logic Behind the Glass-Steagall Act
At the time, around 5000 commercial banks in the US were accused of becoming too greedy by taking on huge amounts of risks in the hope of getting higher rewards. This resulted in their operations becoming sloppy and their objectives becoming more blurred than ever before. It was during this time that loans that were unsound were being issued to companies in the hopes of bigger rewards. What made the situation worse was not only the bad investments that were being made by the banks, but these banks were also encouraging their clients to invest in those same stocks as well.
To take control of this problem the Glass-Steagall Act was introduced as a sort of regulatory firewall between the activities of commercial and investment banks. According to the act, banks were given a time period of one year to decide whether they wanted to specialize in commercial or investment banking after which they would have to operate under the new rules that were set up by the Glass-Steagall Act. The purpose of the barrier was to prevent banks from using deposits in the case of a underwriting job that failed.
According to some financial experts, the repeal of the act in 1999 is the main cause of the credit crisis that hit many countries in 2008. During the credit crash, commercial banks from around the world found themselves straddled with billions in losses because of excessive exposure of their investment banking division to securities and derivatives that were directly tied to home prices in the US.
Coupled with the acquisition of several prominent banks and the conversion of independent investment banks into bank holding companies, the financial crisis of 2008 signaled the demise of the Glass-Steagall Act.
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