Glass-Steagall Act: It's Needed Now More Than Ever


Awhile back, Time Magazine published a list of 25 people responsible for the late 2000s financial crisis. Although the list wasn't ranked, former Citigroup CEO and Chairman Sandy Weill was credited with creating the type of institution that would eventually become too big to fail.

The Glass-Steagall Act is the common name for four provisions of the Banking Act of 1933, which prohibited the merging of commercial and investment banking. It was enacted in response to the 1929 stock market collapse and subsequent financial crisis. The provisions that would eventually become synonymous with Glass-Steagall were intended to separate commercial banking operations from investment banking, with the belief that combining the two subjected depositor funds to risky speculation. However soon after enactment, small steps were gradually taken to weaken the initial intent of the law, culminating with President Clinton signing legislation effectively repealing it in 1998. Maintaining the separation between commercial and investment banking operations, as the initial enactment of the Glass-Steagall intended, could have prevented the need for federal bailout funds. As Timecontributor Justin Fox notes in a piece published shortly after the start of the Great Recession, the real problem with the repeal of Glass-Steagall is the incompatible motivations that drive transaction-oriented investment banking on one hand, and relationship-oriented commercial banking on the other. 

Commercial and investment banks serve very different purposes. Commercial banks provide basic savings and loan services to individuals and businesses. As Justin Fox notes, these types of banks are relationship-based organizations where depositors entrust an organization to safely guard their financial assets, and banks lend out funds with the belief that a debtor will honor their commitment to repay. While commercial banking generates revenue by charging interest on deposited funds loaned out to creditworthy applicants and charging for other financial services, the customer-service nature of this form of banking and the generally non-profit-seeking motivations of depositors creates a clear distinction from investment banking. Investment banking inherently seeks to maximize returns to capital for investors and pays little attention to the societal effects its market-making activities produce. The role the sale of credit default swaps had in the recent financial crisis highlights the danger of large banking institutions housing commercial and investment wings under the same roof. This in combination with lower lending standards contributed to irresponsible practices that were disastrous for the economy. 

The existence of large financial institutions dubbed "too big to fail" exemplifies how dangerous risky financial behavior is to our economy. The fact that failure of the largest financial institutions would have disastrous consequences for the U.S. and global economy justified the federal government taking action to prevent economic collapse. But it also sets a terrible precedent, as an incentive to take greater risk because of government guarantees removes the market-based incentive to not take such risky bets. By contrast, the presence of more numerous smaller more specialized organizations would theoretically allow firms that practice risky investment and lending practices to bear more of the cost, leaving the the economy as a whole less affected. If these large firms are allowed to exist, at the least, regulations must be implemented to limit the chance of similar financial crises arising. The Volcker Rule, despite concerns by some that it does not go far enough, still faces continued delayed implementation. Hopefully 80 years from now the lessons learned during our recent crisis will not be forgotten by future generations.

Anti-regulation voices often mention the loose monetary policies of the Federal Reserve as the impetus for the financial crisis. Although these Fed policies did correlate with risky decision making, it is disingenuous to not to acknowledge the questionable practices of some institutions and their high-ranking executives. Predictably many institutions are up in arms about measures intended to prevent future irresponsible behavior. A recent survey administered to financial professionals shows that the motivation to enrich oneself will be present regardless of Federal Reserve action. Reinstating Glass-Steagall is one necessary step to protect consumers and American taxpayers. Future steps must include measures curbing Wall Street's ability to cause more unnecessary havoc. Blaming low-income and minority homeowners for creating the housing bubble pardons the blatantly fraudulent and deceptive practices of financial institutions that victimized some of the very people taking the blame. Since when was not being financially astute comparable to malicious dishonesty? It is time to start calling the financial industry on its greedy rent-seeking behavior and discouraging people from oversimplifying complex issues. If corporations are entitled to the same rights as an individual American citizen, then they, like an individual American citizen, must also be held accountable for their actions.