Glass-Steagall Act

Definition

The Glass-Steagall Act was a landmark piece of legislation passed in 1933 that aimed to separate commercial banking from investment banking in the United States. Its primary purpose was to restore public confidence in the banking system after the Great Depression by preventing banks from engaging in high-risk investment activities that could jeopardize depositors' funds.

5 Must Know Facts For Your Next Test

1. The Glass-Steagall Act effectively created a barrier between commercial banks, which accepted deposits and made loans, and investment banks, which underwrote and traded securities.
2. This separation was intended to mitigate conflicts of interest and reduce the risk of bank failures that could arise from speculative investments.
3. The act was partially repealed in 1999 with the Gramm-Leach-Bliley Act, leading to increased integration of banking and securities firms.
4. The repeal of the Glass-Steagall Act is often cited as a contributing factor to the 2007-2008 financial crisis due to the risk-taking behavior it encouraged among financial institutions.
5. The act also established important regulatory frameworks that helped shape modern banking practices and consumer protections.

Review Questions

• How did the Glass-Steagall Act address the issues faced by the banking system during the Great Depression?
  • The Glass-Steagall Act aimed to rebuild trust in the banking system after the catastrophic failures that marked the Great Depression. By separating commercial banks from investment banks, it reduced risky practices that could threaten depositor's money, ensuring that banks focused on their traditional roles of accepting deposits and making loans. This separation was crucial for stabilizing a banking sector that had been significantly weakened by speculative activities.
• Evaluate the impact of the repeal of the Glass-Steagall Act in 1999 on the financial landscape of the United States.
  • The repeal of the Glass-Steagall Act allowed for a convergence of commercial banking and investment banking, which fostered an environment where financial institutions could engage in riskier ventures. This integration led to larger financial entities that were 'too big to fail,' raising concerns about systemic risk. The consequences became evident during the 2008 financial crisis when several major banks collapsed or required government bailouts due to their exposure to high-risk assets.
• Discuss how the principles established by the Glass-Steagall Act have influenced modern financial regulations following the 2008 financial crisis.
  • The principles behind the Glass-Steagall Act have been revisited in recent years, particularly after the 2008 financial crisis highlighted vulnerabilities within the banking system. Modern regulations like Dodd-Frank aim to impose stricter oversight on financial institutions and reinstate some degree of separation between commercial and investment banking activities. The conversation around reinstating elements of Glass-Steagall reflects ongoing debates about balancing economic growth with consumer protection and financial stability.

Related terms

Federal Deposit Insurance Corporation (FDIC): A government agency created in 1933 that provides deposit insurance to depositors in U.S. commercial banks and savings institutions, aiming to maintain public confidence in the financial system.

Securities Exchange Act of 1934: A law enacted to regulate the securities industry, including the trading of stocks and bonds, and to protect investors from fraudulent activities.

Dodd-Frank Wall Street Reform and Consumer Protection Act: A comprehensive set of financial reforms passed in 2010 aimed at preventing another financial crisis, which included measures to increase regulation on banks and financial institutions.