Glass Steagall Act Pros And Cons

Advanced Macroeconomics Assignment

“The Takedown of Glass Steagall Act”

Submitted By : Amanjot Singh Roll No : A006

Passed during the time of Great Depression, The Glass- Steagall Act of 1933 (officially known as The Banking Act) bared commercial banks from trading risky securities with their client’s deposits such that it will detach commercial banking from investment banking. Also, this Act created the Federal Deposit Insurance Corporation (FDIC), which assured bank deposits up to a certain amount ($2500 in 1933, now it is $250,000). However, after 25 long years and $300 millions worth of lobbying efforts by banking
and financial-services industries, Clinton Administration with the Gramm-Leach-Bliley Act of 1999 repealed the Glass-Steagall Act. It was considered necessary because the American Government felt that the fragmented market was not allowing the banks achieve economies of scale which is required to serve the customers on a national and global level and it was said that it signified an evolution towards greater efficiency in banking.

It instigated the ‘financialization’ of the American economy, which permitted banks to become bigger in size and more complicated.
In September 2008, when it all came down, the crises was a lot bigger, deeper and precarious than it was expected by the authorities. Often there are debates among economists, politicians and analysts regarding the causes of financial crises and some experts believe that the repeal of the Glass-Steagall Act contributed to the
crises.

According to me, the repeal of Glass-Steagall was not a primary cause of financial crises but one of the factors that contributed to the financial crises and was a part of a general deregulatory push supported by former Fed Chief Alan Greenspan and Henry Paulson who was head of Goldman Sachs during the repeal of the Act and later became head of the Treasury. Even Joseph E. Stiglitz, a Noble Prize-winning economist supports this and I agree that there were other deregulatory measures like Securities and Exchange Commission’s decision in 2004 which allowed big investment banks to increase their debt-to-capital ratio from 12:1 to 30:1 or higher so that they buy more mortgage backed securities which inflated housing bubble further. Commodities Futures Modernization Act of 2000, Bush tax cuts that was later complemented by record low interest rates, rating agencies that faked the numbers, abdication of lending standards and clueless monetary administration, all contributed to the financial crises. Even if the Glass-Steagall Act was there, all the other steps would have led to financial crises. I think that the repeal of the Act permitted the credit bubble to get bigger.
It made banks and other financial institutions more complex and unmanageable.
It is important to understand both side of story.
Those who were against the repeal of the Act like Joseph E. Stiglitz, Elizabeth Warren and John McCain are of the view that it is essential to draw a line between Commercial banks and Investment Banks. Commercial banks are suppose to manage the people’s money conservatively such that in case bank fails, the government will come forward for people interest. Investment banks on the other hand manage money of rich people and institutions, which can take higher risks so as to get higher returns. With the repeal of Glass-Stealgall, investment bank culture came out and banks started aspiring for higher profit, which was only possible through high leverage and risk taking which led to crises. In 2009, legislation was proposed to bring back the repealed provisions of Glass-Steagall Act, which was dropped by Congress because of lobbying efforts of financial
industries.

Supporters of Gramm-Leach-Bliley Act of 1999 put forward facts to support their idea. They say that Bear Stearns, Merrill Lynch and Lehman Brothers, which were at the epicentre of the crises, were pure investment banks which are not covered under Glass-Steagall Act. The same goes with Goldman Sachs and AIG. They argue that big banks like Wachovia and Washington Mutual got into problem because of risky loans to homeowners.
But one thing on which both of them agree is the fact that the repeal of the Act started a wave of bank consolidation- currently, top ten American banks controls 77% of the US bank assets. This has forced government to bail them in case there is risk of financial meltdown and this has given rise to “too-big-to-fail” problem.

There is no academic study that proves that the repeal of Glass-Steagall Act was the primary cause of financial crises but if the Act was there, I am certain that competitors would not or let me say could not have bulked up the way they are now. The banks would have been smaller, manageable and ‘too big to fail’ would not have happened and bailouts or government support might not have been obligatory. The foolish philosophy of self-regulation that led to repeal of the Act contributed greatly to crises and as already discussed above, the repeal was part of the variety of bad ideas. Right now, I want to suggest Congress to be focus towards finding ways in which they can ‘definancialize’ the American economy and reduce the banker’s control. One way to do so is to find somebody from industry who knows finance instead of Wall Street bankers for the posts of Treasury Secretaries.