BACKGROUNDER No. 3104 | APRIL 28, 2016 The Glass–Steagall Act: Unraveling the Myth Norbert J. Michel, PhD Abstract The 1933 Glass–Steagall Act is widely acclaimed for ending abusive and Key Points risky financial practices that led to the Great Depression, but it has a much better reputation than it deserves. The foundation of its supposed n The Glass–Steagall Act, the 1933 success is the Act’s vaunted separation of commercial and investment law that separated commercial banking. In truth, however, this separation was never absolute. The law and investment banking, gained a much better reputation than it implemented general prohibitions on certain activities, but included ever deserved. exceptions in every case. That is, the Act did not implement a complete n separation of commercial and investment banking. Furthermore, there There is virtually no evidence that allowing banks to engage in is virtually no evidence that the combination of commercial and invest- securities activities during the ment banking threatened bank safety in the pre-Glass–Steagall era. In pre-Glass–Steagall era worsened most cases the evidence supports the opposite conclusion, that the com- their financial condition relative to bination actually strengthened banks. In virtually all cases of supposed- those engaged in strictly commer- ly abusive and unsound practices during the pre-Glass–Steagall era, the cial bank activities. evidence cited either refers to a secondary source, is nonexistent, or is ir- n Allowing banks to engage in both relevant because Glass–Steagall did not address the practice specifically. types of financial activities actu- ally strengthened these commer- he 1933 Glass–Steagall Act is still admired by many who believe cial banks relative to their special- Tits separation of commercial and investment banking banned ized peers. the high-risk activities that caused the Great Depression. Yet there n Glass–Steagall did not implement are so many myths and falsehoods surrounding this notion—and a complete separation of com- the Act itself—that it is difficult to comprehend how little sup- mercial and investment bank- porting evidence Congress uncovered prior to passing the bill. In ing. Four of the bill’s sections implemented the separation, and fact, there is virtually no evidence that banks engaging in securi- each one included exceptions, ties activities before the Act passed were in worse financial condi- several of which were used from tion than their specialized peers. The evidence actually suggests the beginning. that banks engaged in both types of financial activities were stron- n The Glass–Steagall separation ger than those institutions engaged in only commercial banking. was little more than a pet project of Senator Carter Glass, who This paper, in its entirety, can be found at http://report.heritage.org/bg3104 regarded securities investment as The Heritage Foundation illegitimate speculative activity. 214 Massachusetts Avenue, NE Reinstating the Glass-Steagall Washington, DC 20002 separation would negatively (202) 546-4400 | heritage.org impact financial intermediation. Nothing written here is to be construed as necessarily reflecting the views of The Heritage Foundation or as an attempt to aid or hinder the passage of any bill before Congress. BACKGROUNDER | NO. 3104 APRIL 28, 2016 Nonetheless, Glass–Steagall’s restrictions still enjoy not repeal the Glass–Steagall Act. The GLBA repealed widespread support more than 80 years after the only two sections of Glass–Steagall, leaving intact Act’s passage. some of the restrictions the 1933 law placed on finan- Numerous analysts have cited the many abusive cial markets.2 Furthermore, although it is true that and reckless investment practices Congress uncov- the GLBA allowed some firms to engage in activities ered prior to passing the Glass–Steagall Act. But from which they had been previously restricted, all of these assertions are exaggerated or untrue. The these activities are still regulated.3 record shows that many of these claims refer to sec- Prior to the GLBA reforms, the financial indus- ondary sources rather than the original record, and try was mainly regulated based on industry bound- to opinions and allegations rather than actual evi- aries.4 In that framework, banks were regulated by dence of abuses. In some cases, commentators refer banking regulators, insurance companies by insur- to evidence against practices that had nothing to do ance regulators, savings and loans by thrift regu- with the combination of investment and commercial lators, and so on. The GLBA shifted the emphasis banking, such as tax avoidance and excessive sala- toward functional regulation, whereby specific com- ries. Nonetheless, over time, the mythical stature mercial activities were to be regulated by the same of Glass–Steagall has grown, especially in the wake regulator, regardless of industry boundaries. Under of the 2008 financial crisis. ThisBackgrounder pro- this new framework, whether a bank, insurance vides a summary of the many misconceptions sur- company, or broker-dealer engaged in a securities- rounding Glass–Steagall and the truths behind them. related activity, the activity would now be regulated by the same financial regulator rather than three The GLBA Did Not Repeal or Deregulate separate agencies.5 Perhaps the most recent Glass–Steagall myth is Thus, it is inaccurate to say that the GLBA dereg- that its repeal caused the 2008 financial crisis. In ulated financial markets.6 The bill expanded allow- particular, many cite the 1999 Gramm–Leach–Bliley able regulated activities for some financial firms. Act (GLBA) as evidence that financial market deregu- Furthermore, the GLBA contained five titles unre- lation caused the 2008 crisis. These critics maintain lated to Glass–Steagall that, in many instances, that the GLBA repealed the Glass–Steagall Act, thus increased financial regulations.7 Regardless, there is leading to excessive risk-taking in deregulated U.S. a great deal of confusion surrounding the GLBA and financial markets.1 There are several problems with Glass–Steagall, and it begins with the Glass–Steagall this story, not the least of which is that the GLBA did Act itself. 1. See, for example, Jim Zarroli, “Visiting New York City, Bernie Sanders Attacks Clinton, ‘Greed’ Of Wall Street,” NPR, January 6, 2016, http://www.npr.org/2016/01/06/462094414/visiting-new-york-city-bernie-sanders-attacks-clinton-greed-of-wall-street (accessed January 6, 2016); James Rickards, “Repeal of Glass-Steagall Caused the Financial Crisis,” U.S. News & World Report, August 27, 2012, http://www.usnews.com/opinion/blogs/economic-intelligence/2012/08/27/repeal-of-glass-steagall-caused-the-financial-crisis (accessed December 21, 2015); and Joseph Stiglitz, “Capitalist Fools,” Vanity Fair, December 31, 2008, http://www.vanityfair.com/news/2009/01/stiglitz200901-2 (accessed December 21, 2015). 2. Specifically, Section 101 of the GLBA repealed Sections 20 and 32 of the 1933 Act but left Sections 16 and 21 intact. A copy of the GLBA is available at http://www.gpo.gov/fdsys/pkg/BILLS-106s900enr/pdf/BILLS-106s900enr.pdf (accessed February 1, 2016). 3. Put differently, while the GLBA changed the financial regulatory framework in the U.S., it did not deregulate firms’ activities. See Norbert J. Michel, “The Myth of Financial Market Deregulation,” Heritage Foundation Backgrounder No. 3094, April 28, 2016, http://www.heritage.org/research/reports/2016/04/the-myth-of-financial-market-deregulation. 4. Aulana Peters and David Powers, “Functional Regulation: Looking Ahead,” Loyola of Los Angeles Law Review, Vol. 18 (1985), pp. 1075–1098, http://digitalcommons.lmu.edu/cgi/viewcontent.cgi?article=1459&context=llr (accessed December 21, 2015). 5. Securities activities are generally regulated by the Securities and Exchange Commission, but there is still some overlapping regulatory authority in the post-GLBA framework. See Simpson, Thacher, & Bartlett, LLP, “The Gramm-Leach-Bliley Act,” November 17, 1999, http://www.stblaw.com/docs/default-source/cold-fusion-existing-content/publications/pub390.pdf?sfvrsn=2 (accessed March 9, 2016). See also Peters and Powers, “Functional Regulation: Looking Ahead,” 1985. 6. It is true that the GLBA’s sponsors referred to the bill as deregulatory, but this fact does not alter the actual details of what the bill accomplished. See Eric Lipton and Stephen Labaton, “Deregulator Looks Back, Unswayed,” The New York Times, November 16, 2008, http://www.nytimes.com/2008/11/17/business/economy/17gramm.html?pagewanted=all&_r=0 (accessed November 19, 2015). 7. See Michel, “The Myth of Financial Market Deregulation.” 2 BACKGROUNDER | NO. 3104 APRIL 28, 2016 The History of Glass–Steagall “unless in any such case there is a permit therefore The Glass–Steagall Act commonly refers to the issued by the Federal Reserve Board; and the Board is Banking Act of 1933, the law that separated commer- authorized to issue such permit if in its judgment it is cial and investment banking in the U.S.8 Though this not incompatible with the public interest.”12 separation is often referred to as the Glass–Steagall Section 16, which the GLBA left intact, generally Act (or simply Glass–Steagall), the legal separation prohibited banks from underwriting or dealing in was only part of a much larger bill. While the legal securities.13 Section 21, which the GLBA also left in separation was implemented in four sections (16, 20, place, generally prohibited investment banks from 21, and 32) of the Banking Act of 1933, the