Economics / Finance

What is Glass Steagall, and Should it be Reinstated?

If you watched the first democratic presidential debate, one point of differentiation between candidates you might have seen was their positions on whether or not to reinstate Glass-Steagall. But what exactly is Glass-Steagall, and why was it originally instated?

To find out we go back to the Great Depression when the law was passed. The Glass-Steagall Act of 1933 was passed by FDR in an attempt to reign in the risky activities being taken by banks at the time that led to the 1929 stock market crash and the Great Depression. Its main function was to disallow financial institutions from participating in both commercial banking and investment banking. Commercial banking refers to banks where the average individual citizen makes deposits, such as Wells Fargo, or PNC Bank, whereas investment banking refers to institutions such as Goldman Sachs that invest in stocks and bonds on capital and money markets.

clinton-signs-billThis legislation remained in place for 66 years, until former President Bill Clinton signed the Gramm-Leach-Bliley Act of 1999, which repealed Glass-Steagall, allowing commercial and investment banks to merge. This act explains why you now see so-called “too big to fail” banks, such as JP Morgan Chase, Citigroup, and Bank of America, which accepts deposits from and provides loans to individuals, but also participates in riskier market investment activities.

Some democratic presidential candidates, namely Vermont Senator Bernie Sanders, and former Maryland Governor Martin O’Malley, are now arguing that Glass-Steagall be reinstated, arguing that its repeal played a significant role in the 2008 financial crisis and recession that followed. Former Secretary of State Hilary Clinton has stated that she would not attempt to reinstate Glass-Steagall if elected president.

The biggest argument currently being made for Glass-Steagall is that megabanks such as JP Morgan Chase had grown so large by the recession that they needed taxpayer bailouts in order to stabilize the economy.

So did the repeal of Glass-Steagall lead to the recession, and would it conceivably prevent another one? Honestly, it is hard to tell, as there were so many other factors that contributed to the crisis. Mainly it was the failure of mortgage-backed securities that caused banks to fail and the economy to spiral out of control. A piece of legislation that is easier to link to the mortgage crisis is the Commodity Futures Modernization Act of 2000, which was also passed by Bill Clinton. The bill prevented the SEC and Commodity Futures Trade Commission from regulating credit default swaps and financial derivative tools, which mortgage-backed securities are a type of.

It is also important to remember that “too big to fail” mega-banks weren’t the sole players in causing the financial collapse. Many investment banks, such as Lehman Brothers and Goldman Sachs, were influential in the collapse, along with non-banking institutions such as AIG (insurance company), which participated in risky shadow banking activities.

If there is any point I’d like to make in closing, it is that many different factors played a role in the economic troubles the 2008 recession caused, some of those factors being more obvious than others. There is not necessarily a clear answer as to whether Glass-Steagall should be reinstated, and whether it would do anything to help prevent another crisis. Nevertheless, the Glass-Steagall debate has reminded the American public that stricter trading regulations may be helpful. The merits of Glass-Steagall will mostly likely continue to be debated going forward, but it is important to remember that there are many other regulatory measures that should also be discussed.

Sources:

http://www.nytimes.com/2015/10/15/upshot/what-is-glass-steagall-the-82-year-old-banking-law-that-stirred-the-debate.html?_r=0

http://theweek.com/articles/583243/what-hillary-gets-right-about-glasssteagall