Pretty much everyone that lives in the United States has heard of the great depression. While in school you learn that the great depression was a period with massive deflation throughout the country. On October 29th, 1929, a day known as Black Tuesday, the share prices on the New York Stock Exchange completely collapsed. This is believed to be a major catalyst for the advent of the great depression. This was not the sole cause of the great depression, but I just say this to give a little context because it is applicable to the Glass-Steagall act. The Glass-Steagall act was signed into law by President Franklin Delano Roosevelt in 1933 within his first 100 days in office as part of his New Deal. It is also known as the Banking Act of 1933.
Before the Glass-Steagall act, banks were able to basically invest in whatever they want. So, the banks that loaned money to regular people for mortgages were also able to invest in assets relatively unrestricted. In other words, there was not difference between commercial and investment banking, and banks were able to do both.
This kind of free-range investment from most banks was believed to have been a major cause for the stock market crash in late 1929 and thus a cause for the great depression. Glass-Steagall put an end to this in many ways.
The act was put together by Senator Carter Glass (D-VA) and Representative Henry Steagall (D-AL) and passed the senate in 1932. However, the house had adjourned before coming to a decision. This caused it to not be signed into law until 1933.
What was the Glass-Steagall act superficially
Essentially, the act gave banks one year to decide if they were going to specialize in commercial or investment banking. Commercial banks are responsible for lending money and other services to the public and companies. An investment bank invests money into a large amount of assets and can resell them to retail investors or hold them for themselves.
This was a big deal because banks would provide loans to companies and then buy their stock. For anyone who knows how equities work, this should hopefully be a red flag. The banks would buy the stock of a company, and then make a large loan to the company for it to grow. This would lead to the share price of the company rising. The banks could then sell the shares if the company would no longer grow or give them a return. This is how they could have aided in the deflationary bust of asset prices in 1929 and the 1930’s.
Due to the Glass-Steagall act, commercial banks were only allowed to have 10% of their total income coming from securities except for government-issued bonds. This gained support from the public because they were concerned about the risk banks were taking with the depositor’s money.
Keep in mind that the rule for 10% only pertains to equities (ownership, i.e., stocks), so these regulations mostly kept commercial banks out of the equity market. Congress later increased the restrictions with the Bank Holding Company Act which defined underwriting insurance as a poor banking practice. This did not prevent banks from selling insurance or insurance products, only from underwriting them.
Federal Deposit Insurance Corporation
Along with the separation of commercial and investment banking, Glass-Steagall also created a few organizations that are still around today. Required to gain the support of Rep. Steagall, the law created the Federal Deposit Insurance Corporation (FDIC). The FDIC insures bank deposits with a pool of money that is collected from the banks. FDR actually threatened to veto the bill due to this provision, however, he did not follow through with it.
When the law was enacted, the FDIC was temporary as of January 1934 and only insured up to $2,500. It later became permanent in July of that year and insured up to $5,000. Throughout the years, the amount had gradually moved up to where your bank deposits are insured up to $250,000 as of today.
Also, due to Glass-Steagall, no state banks could become a member of the Federal Reserve System until they become a stockholder of the FDIC. Basically, a state bank had to add money to the pool of money that insures bank deposits to become a member. This membership in the Federal Reserve System is a huge advantage for banks that will be discussed in later posts as it is an absolutely massive rabbit hole to fall into.
Federal Open Market Committee (FOMC)
The Glass-Steagall act also created the Federal Open Market Committee which is a part of the federal reserve that is responsible for monetary policymaking. In the original act, the voting rights for the federal reserve board were not included, but this was revised in 1935
Regulation Q
Regulation Q is something that came up in one of the articles I read for this post that I think is rather interesting. From what I gathered, regulation Q mandated that interest could not be paid on checking accounts and gave the Fed the authority to place ceilings on the interest of other deposits. Allegedly, the rational is that the banks had to take more risk to pay the interest on checking accounts.
I just thought it was interesting that the Fed was allowed to place ceilings on interest rates for non-checking deposits. When I read this, it raised my eyebrows. So, it is something that I will investigate and probably have its own post later.
Repealed with Gramm Bliley
It should not come as a surprise the Glass-Steagall was repealed and that these restrictions no longer apply to the banks. With the Gramm-Leach-Bliley Act (Financial Services Modernization Act) in November of 1999, the regulations imposed by Glass-Steagall were removed. This led to an increase in speculative activities by banks similar to those done in the 1920’s. It is believed that this increase in speculative activity aided in the rise of subprime lending that led to the 2008 great financial crisis.
Dodd-frank and 2010 touches
The Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in 2010 and repealed regulation Q. This act was also responsible for setting the FDIC limit to today’s value of $250,000.
Final thoughts on Glass-Steagall
It is important to know of Glass-Steagall because understanding how the banking system works, and its history is vital to becoming a successful investor and businessperson. I was listening to a podcast with Jim Rodgers and remember him saying, “If you want to be rich, learn history”. If you do not know who Jim Rodger is, you must look him up. He is a definitely one of those old men with a lot of stories and knowledge that you could listen to for hours.
There is a saying that people hear a lot to explain why it is important to learn history. People say that “history repeats itself”, but this is false. History does not repeat, but it does rhyme. People are different, situations are different, and environments are different, but on aggregate total people tend to react the same and the general mood and reactions to events are similar.
I am not saying the everyone acts the same in each situation because that is obviously false. However, you almost always find that what is happening today has basically happened before in a very similar way if you look deep enough into history.
To your wealth and future,
James Forsythe
Some Resources
[1] https://www.investopedia.com/articles/03/071603.asp
[2] https://www.federalreservehistory.org/essays/glass-steagall-act
[3] https://www.history.com/topics/great-depression/glass-steagall-act
For more important history
https://jamesdforsythe.com/category/important-history/
For more information on the Banking System
