The Glass-Steagall Act, also known as the Banking Act of 1933, was passed by A group of congressmen look on as President Franklin D. Roosevelt signs the Glass-Steagall Act on June 16, 1933. Senators Carter Glass (light suit) and Henry S. Steagall stand on either side of the president.
The first Glass-Steagall Act of 1932 was
Enacted in an effort to stop deflation, and expanded the Federal Reserve's ability to offer rediscounts on more types of assets, such as government bonds as well as commercial paper.
The second Glass-Steagall Act (the Banking Act of 1933) was a reaction to the collapse of a large portion of the American commercial banking system in early 1933.
It prohibits commercial banks from engaging in the investment business.
It was enacted as an emergency response to the failure of nearly 5,000 banks during the Great Depression.
It gave tighter regulation of national banks to the Federal Reserve System; prohibited bank sales of SECURITIES; and created the FEDERAL DEPOSIT INSURANCE CORPORATION (FDIC), which insures bank deposits with a pool of money appropriated from banks.
It restrict or forbid commercial banks from dealing in and holding corporate securities
"But "
This act did not change the most important weakness of the American banking system -- unit banking within states and the prohibition of nationwide banking. All the banks which are collapsed are unit banks with assets of less than $2million.
Beginning in the 1900s, commercial banks established security affiliates that floated bond issues and underwrote corporate stock issues. The expansion of commercial banks into securities underwriting was substantial until the 1929 STOCK MARKET crash and the subsequent Depression. In 1930, the BANK OF THE UNITED STATES failed, reportedly because of activities of its security affiliates that created artificial conditions in the market. In 1933, all of the banks throughout the country were closed for a four-day period, and 4,000 banks closed permanently.
As a result of the bank closings and the already devastated economy, public confidence in the U.S. financial structure was low. In order to restore the banking public's confidence that banks would follow reasonable banking practices, Congress created the Glass-Steagall Act. The act forced a separation of commercial and investment banks by preventing commercial banks from underwriting securities, with the exception of U.S. Treasury and federal agency securities, and municipal and state general-obligation securities. More specifically, the act authorizes Federal Reserve banks to use government obligations and COMMERCIAL PAPER as collateral for their note issues, in order to encourage expansion of the currency. Banks also may offer advisory services regarding investments for their customers, as well as buy and sell securities for their customers. However, information gained from providing such services may not be used by a bank when it acts as a lender. Likewise, investment banks may not engage in the business of receiving deposits.
A bank is defined as an institution organized under the laws of the United States that both accepts demand deposits and is engaged in the business of making commercial loans. Investment banking consists mostly of securities underwriting and related activities; making a market in securities; and setting up corporate mergers, acquisitions, and restructuring. Investment banking also includes services provided by brokers or dealers in transactions in the secondary market. A secondary market is one where securities are bought and sold subsequent to their original issuance.
Despite attempts to reform Glass-Steagall, the legislature has not passed any major changes-although it has passed bills that relax restrictions. Banks may now set up brokerage subsidiaries, and underwrite a limited number of issues such as asset-backed securities, corporate bonds, and commercial paper.
The Glass-Steagall Act restored public confidence in banking practices during the Great Depression.
However, many historians believe that the commercial bank securities practices of the time had little actual effect on the already devastated economy and were not a major contributor to the Depression. Some legislators and bank reformers argued that the act was never necessary, or that it had become outdated and should be repealed.
Congress responded to these criticisms in passing the Gramm-Leach-Bilely Act of 1999, which made significant changes to Glass-Steagall. The 1999 law did not make sweeping changes in the types of business that may be conducted by an individual bank, broker-dealer or insurance company. Instead, the act repealed the Glass-Steagall Act's restrictions on bank and securities-firm affiliations. It also amended the Bank Holding Company Act to permit affiliations among financial services companies, including banks, securities firms and insurance companies. The new law sought financial modernization by removing the very barriers that Glass-Steagall had erected.
The economists and the histotian says that securities abuses played a litle role in the failure of banking system, and it was the result of great depression 1929.
Where the senator glass strongly believed that bank involvement with securities was detrimental to the Federal Reserve system, is not according to the rules of good banking, and responsible for stock market speculation, the Crash of 1929, bank failures, and ultimately brings the Great Depression.
Provisions of the Glass-Steagall Act were directed at these abuses:
Banks were investing their own assets in securities with consequent risk to commercial and savings deposits. The concern of Congress to block this evil is clearly stated in the report of the Senate Banking and Currency Committee on an immediate forerunner of the Glass-Steagall Act.
Unsound loans were made in order to shore up the price of securities or the financial position of companies in which a bank had invested its own assets.
A commercial bank's financial interest in the ownership, price, or distribution of securities inevitably tempted bank officials to press their banking customers into investing in securities which the bank itself was under pressure to sell because of its own pecuniary stake in the transaction.
The original reasons and arguments for legally separating commercial and investment banking include:
Risk of loses (safety and soundness). Banks that engaged in underwriting and holding corporate securities and municipal revenue bonds presented significant risk of loss to depositors and the federal government that had to come to their rescue; they also were more subject to failure with a resulting loss of public confidence in the banking system and greater risk of financial system collapse.
Conflicts of interest and other abuses. Banks that offer investment banking services and mutual funds were subject to conflicts of interest and other abuses, thereby resulting in harm to their customers, including borrowers, depositors, and correspondent banks.
Improper banking activity. Even if there were no actual abuses, securities-related activities are contrary to the way banking ought to be conducted.
Producer desired constraints on competition. Some securities brokers and underwriters and some bankers want to bar those banks that would offer securities and underwriting services from entering their markets.
The Federal 'safety net' should not be extended more than necessary. Federally provided deposit insurance and access to discount window borrowings at the Federal Reserve permit and even encourage banks to take greater risks than are socially optimal. Securities activities are risky and should not be permitted to banks that are protected with the federal 'safety net'.
Unfair competition. In any event, banks get subsidized federal deposit insurance which gives them access to 'cheap' deposit funds. Thus they have market power and can engage in cross-subsidization that gives them an unfair competitive advantage over non-bank competitors (e.g. Securities brokers and underwriters) were they permitted to offer investment banking services.
Concentration of power and less-than-competitive performance. Commercial banks' competitive advantages would result in their domination or takeover of securities brokerage and underwriting firms if they were permitted to offer investment banking services or hold corporate equities. The result would be an unacceptable concentration of power and less-than-competitive performance.
Universal v. Specialized Banking. If the Glass-Steagall Act were repealed, the U.S. Banking system would come to resemble the German universal system, which would be detrimental to bank clients and the economy.
Refrences
http://www.cftech.com/BrainBank/SPECIALREPORTS/GlassSteagall.html
http://en.wikipedia.org/wiki/Glass%E2%80%93Steagall_Act
http://law.jrank.org/pages/7165/Glass-Steagall-Act.html
