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Posted on 11 April 2011 | 5,506 views

Glass Steagall Act and Market Crashes

The Glass-Steagall Act of 1933, also known as the Banking Act of 1933, separated banking according to the types of banking business — commercial banking and investment banking. It was passed when a large portion of the U.S. banking system collapsed during the Great Depression in the 1920s and 1930s.

Two Democratic lawmakers, Senator Carter Glass of Virginia and Henry Steagall of Alabama sponsored bills which became known as the Glass-Steagall Act of 1933.

When the stock market crashed in 1929, it was essentially the beginning of the Great Depression, very similar to the beginning of the Great Recession in 2008. The Glass-Steagall Act was a reaction to the fact that banks, before the Great Depression, had mixed the commercial and investing activities and regulators felt that this had caused banks to take too much risk with depositors’ money.

After the enactment of Glass-Steagall, commercial banks could accept depositor’s money and make loans but could not become involved in selling or trading in risky or speculative financial instruments, securities or underwriting.

Along with the other provisions of the Glass-Steagall Act, it also created the Federal Deposit Insurance Corporation (FDIC). The FDIC is a government corporation that insures the safety of depositors’ money up to $250,000 per depositor per bank.

The FDIC examines and supervises member banks for safety and soundness and supervises failed banks. Like the Glass-Steagall Act, the FDIC grew out of the events of the Great Depression. Because there was no deposit insurance at that time, there were bank runs. Depositors fled to banks when the Depression hit to try to withdraw their money. This made the Depression worse.

When 2008 came and the Great Recession occurred, the FDIC increased its depositor insurance amount to $250,000 from $100,000 per bank per depositor to increase consumer confidence. That limit will expire at the end of 2013 and will revert back to $100,000.

Because Wall Street used depositors’ money to make risky investments, resulting in the Great Recession of 2008-09, President Obama is thinking about re-enacting at least parts of the Glass-Steagall Act. He would like to name his new act the Volcker Rule after Paul Volcker, former Chair of the Federal Reserve, who is a defender of the Glass-Steagall Act.

The Volcker Rule, at least according to Obama’s first thoughts, would stop banks from playing the market with depositors’ money, participating in hedge funds and making private equity investments. In addition, there would be no more mergers between big banks. The thinking is still fluid on this rule, so nothing is certain yet.

However, the Volcker rule or something like it would end the “too big to fail” mentality and clean up the banks. It just might save us from another financial crisis.

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