Glass-Steagall Act Was Designed to Restore Public Confidence in Broken Banking System

The law that has come to be known as “Glass-Steagall” was a product of the Great Depression and was designed to guard against a repetition of that calamity.

In the depths of the Depression, the Senate Banking Committee was examining the causes of the stock market crash of 1929. After focusing on Wall Street corruption, the hearings had switched in January, 1933, to the misdeeds of bankers.

The chairman was Sen. Carter Glass, a powerful Virginia Democrat and former Treasury secretary, who had sponsored the bill that established the Federal Reserve in 1913. His House counterpart was Rep. Henry B. Steagall, a Democrat from Alabama.

One witness was Charles A. Mitchell, head of National City Bank in New York and its securities subsidiary, National City Co. The securities affiliate had sold hundreds of millions of dollars worth of stocks and bonds to bank customers. Among the stocks was National City Bank. In turn, the bank had used the stocks and bonds as collateral for high-interest loans.

Glass had long felt that such rising integration of the financial markets had played a major role in the collapse of the economy, and the encroachment of banks into the securities field was a prime example.

Financial historians, such as Edwin J. Perkins of USC, maintain today that few of the thousands of bank failures in the 1930s were the result of links between securities firms and banks. But Glass used the hearings to mobilize support for his view and the result was the Banking Act of 1933.

The law was designed to restore public confidence in the banking system. It set limits on deposit interest, which were later abolished, and created the Federal Deposit Insurance Corp. to insure bank accounts. But to receive those insured accounts, commercial banks were required to abandon the speculative securities arena, known as investment banking.

The few paragraphs in the law that separate commercial banking from investment banking are clear and simple. Commercial banks may not underwrite or trade securities and may not be affiliated with domestic companies that do. In turn, securities firms may not take deposits or own domestic banks that do.

The debate over Glass-Steagall today deals only with that separation and whether it is necessary. No one has proposed abandoning the FDIC, although Glass was dubious in 1933 about the concept’s eventual success.