A bi-partisan group of lawmakers proposed a bill on Thursday that, if passed, could have the most significant impact on the financial industry of any legislative action since the Great Depression.
Massachusetts Senator Elizabeth Warren was joined by Arizona’s John McCain, along with Maria Cantwell (D-WA) and Angus King (I-ME) in proposing to essentially reinstate the Glass-Steagall provisions of the 1933 Banking Act.
When politicians, journalists, economists, historians, and activists talk about the Glass-Steagall Act, what they are usually referring to is the historic legislation that separated commercial and investment banking in the wake of the great depression. The history of Glass-Steagall is, however, slightly more nuanced.
Named after its sponsors, Senator Carter Glass of Virginia, a former Secretary of the Treasury, and Congressman Henry Steagall of Alabama, Chairman of the House Committee on Banking and Currency, the original Glass-Steagall act of 1932 authorized Federal Reserve Banks to lend to other member-banks of the Federal Reserve System on a group basis, and in unusual or temporary circumstances, to individual member-banks with less than $5 million in capital against any satisfactory collateral. It also authorized Reserve Banks to issue paper currency guaranteed by US government securities, as opposed to gold, in the event of a shortage of bills.
So the 1932 act itself had little to do with putting a firewall between commercial and investment banking. This would come the following year with the Banking Act of 1933, in which the same two Senators were instrumental in drafting key sections of the bill. In particular:
-Section 16 prohibited national banks from underwriting of distributing securities, as well as purchasing or selling them, unless this was done for a customer’s account, or unless the securities were purchased for the bank’s account under the rubric of “investment securities.” This section also permitted national banks to buy, sell, underwrite, and distribute US government and general obligation state and local government securities, which became known as “bank-eligible securities.”
-Section 5(c) applied Section 16’s rules to the Federal Reserve System’s member-state chartered banks.
-Section 20 prohibited any member bank of the Federal Reserve System, state-chartered or national, from affiliations with companies that issued, underwrote, or sold securities.
- Section 21 prohibited any company or person from taking deposits if for the sake of issuing, underwriting, selling, or distributing securities.
-Finally, section 32 prohibited any Federal Reserve System member bank from having any officer or director in common with a company engaged primarily in the business of purchasing, selling, or negotiating securities, unless the board of the Federal Reserve granted an exemption.
The 1933 legislation also reduced the timeline for banks to eliminate their dealings in securities from 5 years to 1 year.
Despite the role of the banking industry in causing and/or exacerbating Great Depression, the corrective Glass-Steagall provisions were nonetheless considered very drastic, and opposition to the Banking Act, or at least some of its components, was immediate. Some two years after its passage, Senator Glass himself would attempt to repeal parts of section 16, an effort that was stymied by President Franklin Roosevelt, who was concerned about the return of the same old abuses.
Ever since the passage of the Banking Act, the Glass-Steagall portion of the law has been under some form of attack, from President John F. Kennedy’s Comptroller of the Currency James Saxon, to the private sector-friendly administration of Ronal Reagan, to its final demise at the end of the Clinton administration in the late 1990s.
By 1999, the Glass-Steagall provisions of the Banking Act had already been eroded to the point that they were, at best, a nostalgic formality that was routinely circumvented by the Federal government’s use of the power to make temporary exemptions to certain of the law’s more onerous restrictions. Thus, the Graham-Leach-Bliley act, otherwise known as the Financial Services Modernization Act of 1999, did away with what had in some respects become a decorative set of restrictions.
Less than a decade later, however, that decision would prove to be at least questionable as the financial crisis took a huge bite out of the global economy and the Federal Government found itself in the unfortunate position of bailing out enormous financial institutions whose pending insolvency and bankruptcy had the potential to disrupt the already desperate situation even further.
From 2008 onwards, the repeal of Glass-Steagall became one of the most common explanations for how the US financial system had so suddenly almost completely collapsed, though there had been no shortage of prominent economists such as Elizabeth Warren and Nobel Prize laureate Joseph Stiglitz who had been highly critical of the decision from the outset.
Critics of the repeal pointed to the fact that removing the boundaries between commercial and investment banking had allowed already huge banks to become even larger than before, and certainly larger than they had ever been in the history of late capitalism.
Furthermore, critics noted how the blurring of the lines between two very different types of banking essentially legalized a conflict of interest that could only end in favor of riskier practices. The exponential availability and use of new and opaque financial instruments, such as credit default swaps and over the counter derivatives that were far out of reach of the traditional financial regulatory regime, were named among the main culprits for the 2008 disaster.
Fast-forward to the present: the Oklahoma-born Warren, a Harvard Law School professor who has specialized in bankruptcy, first garnered recognition on a large scale as the brains behind the creation of the Consumer Financial Protection Bureau in 2011. The Bureau was established subsequent to the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Washington’s response to widespread public anger against the financial industry in the wake of the 2008 crisis.
It was largely believed that Warren would go on to head the Bureau she helped create, and it would be hard indeed to think of someone more qualified for the job, given her long history as an eloquent and vastly erudite consumer advocate. But the financial industry reacted as though they were seeing the return of Brooksley Born, who in the mid-1990s as the head of the Commodity Futures Trading Commission suffered the wrath of Federal Reserve representatives and others in positions of power in the world of finance after having the temerity to suggest regulating the lucrative over-the-counter trading industry that had blossomed during the last decade of the millenium.
One of the provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2011, the policy-response to the financial industry’s role in the economic collapse three years previous, called for the establishment of the Consumer Financial Protection Bureau. But strong opposition from the President Obama’s political opposition saw him backing down on Warren’s appointment to head the bureau, opting instead for the less controversial former Ohio attorney general Richard Cordray.
But Warren would go on to win a seat in the Massachusetts senate in 2012, putting her in perhaps an even better position than before to make her case against the power of large banking institutions. Last week’s introduction of a “21st Century Glass-Steagall,” with its high-profile bi-partisan backing, would seem to support this contention. The bill would pry apart and ensure the separation between commercial and investment banking, and would fit nicely both with the provisions of Dodd-Frank, as well as other bi-partisan legislation recently proposed by Senators Sherod-Brown (D-Ohio) and David Vitter (R-Louisana), that seeks to finally address the issue of too-big-to-fail banks.
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