Glass Steagall

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The Glass-Steagall Act of 1933 established the Federal Deposit Insurance Corporation (FDIC) in the United States and included banking reforms, some of which were designed to control speculation.[1]

Some provisions such as Regulation Q, which allowed the Federal Reserve to regulate interest rates in savings accounts, were repealed by the Depository Institutions Deregulation and Monetary Control Act of 1980. Provisions that prohibit a bank holding company from owning other financial companies were repealed on November 12, 1999, by the Gramm-Leach-Bliley Act[2] [3].

See break up banks, leverage, narrow banks, resolution authority and Too Big to Fail.

Contents

Discussion in the 111th Congress

S 2886 Banking Integrity Act of 2009

111th CONGRESS, 1st Session

S. 2886 To prohibit certain affiliations (between commercial banking and investment banking companies), and for other purposes.

Sponsor

Sen Cantwell, Maria [WA]

Co-Sponsors

  • Sen Boxer, Barbara [CA] - 12/17/2009
  • Sen Feingold, Russell D. [WI] - 12/16/2009
  • Sen Kaufman, Edward E. [DE] - 12/18/2009
  • Sen McCain, John [AZ] - 12/16/2009
  • Sen Sanders, Bernard [VT] - 12/17/2009


IN THE SENATE OF THE UNITED STATES December 16, 2009

Ms. CANTWELL (for herself, Mr. MCCAIN, and Mr. FEINGOLD) introduced the following bill; which was read twice and referred to the Committee on Banking, Housing, and Urban Affairs

To prohibit certain affiliations (between commercial banking and investment banking companies), and for other purposes.

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled, SECTION 1. SHORT TITLE.

This Act may be cited as the `Banking Integrity Act of 2009'.

SEC. 2. RESTORING LIMITATIONS ON FINANCIAL INSTITUTION AFFILIATIONS.

(a) Limitation on Affiliation- The Banking Act of 1933 (12 U.S.C. 221a et seq.) is amended by inserting before section 21 the following: `Sec. 20. Beginning 1 year after the date of enactment of the Banking Integrity Act of 2009 , no member bank may be affiliated, in any manner described in section 2(b), with any corporation, association, business trust, or other similar organization that is engaged principally in the issue, flotation, underwriting, public sale, or distribution at wholesale or retail or through syndicate participation stocks, bonds, debenture, notes, or other securities, except that nothing in this section shall apply to any such organization which shall have been placed in formal liquidation and which shall transact no business, except such as may be incidental to the liquidation of its affairs.'. (b) Limitation on Compensation- The Banking Act of 1933 (12 U.S.C. 221 et seq.) is amended by inserting after section 31 the following:

`Sec. 32. Beginning 1 year after the date of enactment of the Banking Integrity Act of 2009, no officer, director, or employee of any corporation or unincorporated association, no partner or employee of any partnership, and no individual, primarily engaged in the issue, flotation, underwriting, public sale, or distribution, at wholesale or retail, or through syndicate participation, of stocks, bonds, or other similar securities, shall serve simultaneously as an officer, director, or employee of any member bank, except in limited classes of cases in which the Board of Governors of the Federal Reserve System may allow such service by general regulations when, in the judgment of the Board of Governors, it would not unduly influence the investment policies of such member bank or the advice given to customers by the member bank regarding investments.'.

SEC. 3. PROHIBITING DEPOSITORY INSTITUTIONS FROM ENGAGING IN INSURANCE-RELATED ACTIVITIES.

(a) In General- Beginning 1 year after the date of enactment of this Act, and notwithstanding any other provision of law, in no case may a depository institution engage in the business of insurance or any insurance-related activity. (b) Definition- As used in this section, the term `business of insurance' means the writing of insurance or the reinsuring of risks by an insurer, including all acts necessary to such writing or reinsuring and the activities relating to the writing of insurance or the reinsuring of risks conducted by persons who act as, or are, officers, directors, agents, or employees of insurers or who are other persons authorized to act on behalf of such persons.


McCain and Cantwell to introduce legislation restoring GS

U.S. Senators John McCain and Maria Cantwell proposed reinstating the Depression-era Glass-Steagall Act that split commercial and investment banking to rein in Wall Street firms in response to the financial crisis.

“Under our proposal, too-big-to-fail banks would be forced to return to the business of conventional banking, leaving the task of risk taking or management to others,” McCain, an Arizona Republican, said at a Washington news conference. A former bank regulator said splitting up companies is “crazy.”

McCain and Cantwell, a Washington Democrat, join other lawmakers in Congress proposing to reinstate the 1933 law, repealed a decade ago by the Gramm-Leach-Bliley Act that led to a rise in conglomerates including Citigroup Inc., JPMorgan Chase & Co. and Bank of America Corp. active in retail banking, insurance and proprietary trading.

Under the legislation, financial firms operating commercial banks and investment houses will have to decide whether to focus on commercial banking or investment banking. It would ban commercial banks from engaging in insurance activities. Cantwell said the companies would get a year from enactment to comply with the law.

“Trying to split them up is crazy,” John Douglas, who leads the bank regulatory practice at Davis Polk & Wardwell in New York and a former general counsel at the Federal Deposit Insurance Corp., said in a telephone interview. “The integration of the securities and banking function came about because of the need of large corporate customers to have integrated banking and securities services.”

JPMorgan, Citigroup

The legislation would require New York-based JPMorgan to give up trading operations acquired from Bear Stearns Cos. and split from Chase, according to a summary from Cantwell and McCain. Bank of America, the largest U.S. bank by assets and deposits, and Merrill Lynch & Co. would need to separate.

Goldman Sachs Group Inc. could no longer be a bank-holding company that accepts federally insured deposits, according to the summary. It was approved as a bank-holding company during the credit crisis last year to gain Federal Reserve support. Citigroup would have to shed its multiple non-commercial banking affiliates.

“Wall Street firms are about to post soaring end-of-the- year profits and bonuses, while Main Street suffers and wonders when they will have their recovery,” Cantwell said.

Cantwell and McCain said the profits touched off public anger toward bankers, while the president of the Independent Community Bankers of America said a “growing realization” has emerged in Congress the repeal may have been a mistake.

‘No Accident’

“We cruise along for 80 years without a major calamity infecting the entire financial system and then less than eight years after the repeal of Glass-Steagall we have a financial meltdown in this country,” Camden Fine, president of the Washington-based trade group for about 5,000 smaller U.S. banks, said in a telephone interview. “That’s no accident.”

Schumer says Glass Steagall "something we should look at"

"...At the same time, reinstating the Depression-era Glass- Steagall Act that split investment and commercial banking should be considered, yet is “easier said than done,” he said. Last week, lawmakers including Senator John McCain proposed reinstating Glass-Steagall, which was struck in 1999 by the Gramm-Leach-Bliley Act.

The repeal led to a rise in conglomerates including Citigroup Inc. that were allowed to branch into insurance and proprietary trading.

Schumer backed the 1999 law, saying at the time that “the future of America’s dominance as the center of the financial world is at stake.” As a House member in 1987, he had opposed repealing Glass-Steagall. A Democrat, he’s now in his second term as a senator from the state that includes Wall Street’s biggest firms.

‘Loophole’

Schumer, who sits on the banking and finance committees, said the proposal is “something we should look at” because proprietary trading is different from other parts of the business. Some issues include how to square such a change with less-stringent foreign regulation and with “loophole after loophole” created by the Federal Reserve under former Chairman Alan Greenspan, Schumer said...."

H.R. 4375 ‘Glass-Steagall Restoration Act’

  • Source: H.R. 4375 Rep. Maurice Hinchey [D-NY22], December 16, 2009, Govtrak.us

To restore certain provisions of the Banking Act of 1933, commonly referred to as the ‘Glass-Steagall Act’, and for other purposes.

Cosponsors:

  • Rep. Maurice Hinchey [D-NY22]
  • Peter DeFazio [D-OR4]
  • Jay Inslee [D-WA1]
  • Marcy Kaptur [D-OH9]
  • James McDermott [D-WA7]
  • John Tierney [D-MA6]


H.R. 4377 - Return to 'Prudent Banking Act of 2009’

  • Source: H.R. 4377 Rep. Marcy Kaptur [D-OH9], December 16, 2009, Govtrak.us

To repeal certain provisions of the Gramm-Leach-Bliley Act and revive the separation between commercial banking and the securities business, in the manner provided in the Banking Act of 1933, the so-called ‘Glass-Steagall Act’, and for other purposes.

Ms. KAPTUR introduced the following bill; which was referred to the Committee on Financial Services


House discussion

The U.S. House is considering reinstituting the Depression-era Glass-Steagall Act, which barred bank holding companies from owning other financial companies, Majority Leader Steny Hoyer said today.

A renewal of the 1933 law “is certainly under discussion” by House members, Hoyer, a Maryland Democrat, told reporters in Washington. The Glass-Steagall law was repealed in 1999 to help pave the way for the formation of Citigroup Inc. by the $46 billion merger of Citicorp and Travelers Group Inc.

“As someone who voted to repeal Glass-Steagall, maybe that was a mistake,” Hoyer said.

Hoyer made the comments when asked whether Congress and President Barack Obama’s administration could do more to persuade banks to make more business loans and get credit flowing into the economy. Obama met yesterday with the chief executive officers of U.S. banks, urging them to lend more money. The U.S. House passed legislation Dec. 11 that would overhaul regulation of Wall Street.

The Glass-Steagall law barred banks that took deposits from underwriting securities. The 1999 law that repealed it enabled the creation of “financial holding companies” that combine banks with insurers or investment banks.

Enactment of that law has generated debate about whether it helped spawn reckless lending practices and financial speculation that led to the meltdown of credit markets last year and the $700 billion U.S. bailout of troubled banks, including Citigroup.

Goldman, Morgan Stanley

The change in law made it possible for Goldman Sachs Group Inc. and Morgan Stanley, the two biggest U.S. securities firms, to convert into bank holding companies, enabling them to get cheap funding from the Federal Reserve during the financial crisis. If Glass-Steagall hadn’t been repealed, Bank of America Corp. wouldn’t have been allowed to acquire Merrill Lynch & Co.

Resurrecting Glass-Steagall might require undoing some of those transactions unless Congress included an exception for those already carried out.

Such a change in law also would reduce the need for the taxpayer bailouts that added between 9 percent and 49 percent to the profits of the 18 biggest U.S. banks in 2009, according to Dean Baker, co-director of the Center for Economic & Policy Research in Washington.

Bernanke

Even so, Fed Chairman Ben Bernanke told the Economic Club of New York on Nov. 16, “Plenty of firms got into trouble making regular commercial loans, and plenty of firms got into trouble in market-making activities.”

“The separation of those two things per se would not necessarily lead to stability,” Bernanke said.

Obama’s meeting with the bankers yesterday “was a good thing for the president to do,” Hoyer said. “The president needs to make it very clear that we expect some help from the private sector to help bring this economy back.”

Obama “has got to go further than that,” Hoyer said, noting that the administration is considering direct lending from the Troubled Asset Relief Program to small businesses.

Former Citibank Chairman John S. Reed apologized in a Nov. 6 interview for helping engineer the bank’s merger with Travelers and for his role in building a company that took $45 billion in U.S. assistance. Reed also recanted his advocacy of the repeal of Glass-Steagall.

The 1998 merger depended on Congress repealing Glass- Steagall before a five-year deadline that otherwise would have required Travelers to sell its insurance underwriting business.

‘Learn From Our Mistakes’

“We learn from our mistakes,” Reed said in the interview. “When you’re running a company, you do what you think is right for the stockholders,” Reed said. “Right now, I’m looking at this as a citizen.”

Jim Leach, the former Republican chairman of the House Financial Services Committee, defended the repeal in an April 22 speech at a conference on financial reform sponsored by Boston University Law School and the Bretton Woods Committee.

“Changes in Glass-Steagall did not precipitate this crisis,” according to a text of the speech by Leach, now chairman of the National Endowment for the Humanities.

Arguments for reinstatement

Arguments against reinstatement

" ... “If you look at what happened, with or without Glass- Steagall, it would have made no difference,” said H. Rodgin Cohen, chairman of New York-based law firm Sullivan & Cromwell LLP, who represented one side or the other in more than a dozen transactions stemming from the financial crisis last year, including the rescues of Bear Stearns Cos., Fannie Mae, Wachovia Corp., and American International Group Inc.

Cohen and others say the law wouldn’t have saved Bear Stearns or Lehman Brothers Holdings Inc., both of which were pure investment banks, from collapse. And the government would not have been able to enlist JPMorgan Chase & Co. to take on the assets of Bear Stearns or allow Goldman Sachs Group Inc. and Morgan Stanley to become bank holding companies, giving them access to the Federal Reserve’s discount window.

Rather than split up banks, regulators should provide better supervision and require tougher capital requirements, said Cohen, who was also involved on behalf of banking clients in shaping the bill that dismantled parts of Glass-Steagall..."

" ...Jeff Harte, an analyst who covers Bank of America, JPMorgan and Citigroup for Sandler O'Neill + Partners L.P., argues that's it's too soon to engage in much speculation on the subject. Passing the bill — then implementing it — would be a sizable challenge, he said, given the 10 years that have passed since Glass-Steagall was repealed.

“If there are proposals floating around, you certainly can't ignore it,” Mr. Harte said. “But it just seems to me that with the amount of integration that has gone on at the large banks with investment banks in them, unwinding those organizations domestically would be a challenge. And then from an international, competitive standpoint, it would probably make the U.S. banks weaker relative to their peers.” ..."

Volker on restoring Glass Steagall

"The mighty Paul Volcker, of course.

Wall Street was in a spin on Thursday as everyone awaited firm details on the Obama administration’s move to ban proprietary trading by deposit-taking institutions — an action that has inevitably been dubbed the Glass-Steagall sequel.

The President was due to formally announce the news after a meeting earlier with Mr Volcker, who is of course chairman of Obama’s Economic Advisory Board.

So here’s the former Fed chairman talking to Business Week just before the New Year in an interview with Charlie Rose. Extract:

Let’s talk about the financial system. You have said it failed the test of the marketplace.

Yes. It collapsed on us. And I think that’s the test of a financial system—is it facilitating reasonable stability and growth? No, it’s had a breakdown at great risk to the economy. It became dysfunctional, and it is still largely dependent upon government assistance.

How should we create a well-oiled financial system?

The kind of reform I’ve been advocating is acceptance of the fact that the core of the system remains commercial banking. If that breaks down then you have an enormous crisis. And commercial banks have expanded into areas I don’t think are so central. I would cut back their so-called capital market activities—hedge funds, equity funds, commodities trading, trading in derivatives. They’re all legitimate functions, but they’re not so central. And I don’t want to protect all those functions. I don’t want to protect everybody because when people act like they’re protected, you get in trouble. So let’s leave the capital markets to their own devices without any expectation of government protection and keep the existing safety net for the commercial banking system.

In my judgment we don’t need to regulate the capital markets so heavily. You have some extreme cases where individual institutions are so big and so vulnerable, yes, you might want some regulation of capital and leverage, but that would be the exception. But if they fail, let ‘em fail. We will have some kind of a new resolution process. Some agency will go in there and say, “You’re going to fail, but we’re going to provide a more orderly exit.”

But if you’re a commercial bank, no matter how big you are, you should not be allowed to fail?

I wouldn’t go so far as to say you’re not going to be allowed to fail, but you’re going to have a lot more protection available so that it would take pretty extreme circumstances to fail to the point that the institution disappears. The quid pro quo for that is more regulation and a limitation on your activities. I don’t want [commercial banks] out doing a lot of speculative trading.

So does this mean we should restore Glass-Steagall?

No. That’s a false statement people make about my position. Glass-Steagall basically said banks cannot underwrite corporate securities or deal with corporate securities. But I would let commercial banks do underwriting of corporate customers. So you could argue that what I propose is somewhat in the spirit of Glass-Steagall in making a distinction between capital-market activities and trading activities and banking activities. But it is not specifically going back to Glass-Steagall.

Do you think that Congress will see it your way?

Eventually, yes. They need a little more persuasion.

That last point is important.

The snap political analysis of this is that it has pinned the Republicans in a position where they will have to spend the next 10 months in the run-up to the mid-term elections lobbying on behalf of Wall St.

In the US at the moment, that’s not a smart place to be.

Repeal of the Act - 1999

See also Depository Institutions Deregulation and Monetary Control Act of 1980, the Garn-St. Germain Depository Institutions Act of 1982, and the Gramm-Leach-Bliley Act of 1999.

The bill that ultimately repealed the Act was introduced in the Senate by Phil Gramm (Republican of Texas) and in the House of Representatives by Jim Leach (R-Iowa) in 1999. The bills were passed by Republican majorities on party lines by a 54-44 vote in the Senate[4] and by a 343-86 vote in the House of Representatives [5].

After passing both the Senate and House the bill was moved to a conference committee to work out the differences between the Senate and House versions. The final bill resolving the differences was passed in the Senate 90-8 (1 not voting) and in the House: 362-57 (15 not voting). The legislation was signed into law by President Bill Clinton on November 12, 1999.[6]

The banking industry had been seeking the repeal of Glass-Steagall since at least the 1980s. In 1987 the Congressional Research Service prepared a report which explored the case for preserving Glass-Steagall and the case against preserving the act.

The argument for preserving Glass-Steagall (as written in 1987):

1. Conflicts of interest characterize the granting of credit -- lending -- and the use of credit -- investing -- by the same entity, which led to abuses that originally produced the Act.

2. Depository institutions possess enormous financial power, by virtue of their control of other people’s money; its extent must be limited to ensure soundness and competition in the market for funds, whether loans or investments.

3. Securities activities can be risky, leading to enormous losses. Such losses could threaten the integrity of deposits. In turn, the Government insures deposits and could be required to pay large sums if depository institutions were to collapse as the result of securities losses.

4. Depository institutions are supposed to be managed to limit risk. Their managers thus may not be conditioned to operate prudently in more speculative securities businesses. An example is the crash of real estate investment trusts sponsored by bank holding companies (in the 1970s and 1980s).

The argument against preserving the Act (as written in 1987):

1. Depository institutions will now operate in “deregulated” financial markets in which distinctions between loans, securities, and deposits are not well drawn. They are losing market shares to securities firms that are not so strictly regulated, and to foreign financial institutions operating without much restriction from the Act.

2. Conflicts of interest can be prevented by enforcing legislation against them, and by separating the lending and credit functions through forming distinctly separate subsidiaries of financial firms.

3. The securities activities that depository institutions are seeking are both low-risk by their very nature, and would reduce the total risk of organizations offering them -- by diversification.

4. In much of the rest of the world, depository institutions operate simultaneously and successfully in both banking and securities markets. Lessons learned from their experience can be applied to our national financial structure and regulation.

Financial events following the repeal

The repeal enabled commercial lenders such as Citigroup, which was in 1999 the largest U.S. bank by assets, to underwrite and trade instruments such as mortgage-backed securities and collateralized debt obligations and establish so-called structured investment vehicles, or SIVs, that bought those securities.(Barth et al, Policy Watch: The Repeal of Glass-Steagall and the Advent of Broad Banking, 2000, Journal of Economic Perspectives, pages 191–204, Volume 14, Issue 2, [7] It is believed by some including Elizabeth Warren [8], co-author of All Your Worth: The Ultimate Lifetime Money Plan (Free Press, 2005) (ISBN 0-7432-6987-X) and one of the five outside experts who constitute the Congressional Oversight Panel of the Troubled Asset Relief Program, that the repeal of this act contributed to the global financial crisis of 2008–2009[9][10], although some maintain that the increased flexibility allowed by the repeal of Glass-Steagall mitigated or prevented the failure of some American banks.[11]

The year before the repeal, sub-prime loans were just 5% of all mortgage lending. By the time the financial crisis of 2007–2009 peaked in 2008, they were approaching 30%. Although, this correlation is not necessarily an indication of causation, as there are several other significant events that have impacted the sub-prime market during that time. These includes the adoption of mark-to-market accounting, implementation of the Basel Accords, the rise of adjustable rate mortgages etc.[12]

Background

Two separate United States laws are known as the Glass-Steagall Act.

Both bills were sponsored by Democratic Senator Carter Glass of Lynchburg, Virginia, a former Secretary of the Treasury, and Democratic Congressman Henry B. Steagall of Alabama, Chairman of the House Committee on Banking and Currency.

The first Glass-Steagall Act was passed in February, 1932 in an effort to stop deflation and expanded the Federal Reserve's ability to offer rediscounts on more types of assets such as government bonds as well as commercial paper.[13] The second Glass-Steagall Act was passed in 1933 in reaction to the collapse of a large portion of the American commercial banking system in early 1933.

Although Republican President Herbert Hoover had lost reelection in November 1932 to Democratic Governor Franklin D. Roosevelt of New York, the administration did not change hands until March 1933. The lame-duck Hoover Administration and the incoming Roosevelt Administration could not, or would not, coordinate actions to stop the run on banks affiliated with the Henry Ford family that began in Detroit, Michigan, in January 1933. The Federal Reserve chairman Eugene Meyer was equally ineffectual.

While many economic historians attribute the collapse to the economic problems which followed the stock market crash of 1929, some economists attribute the collapse to gold-backed currency withdrawals by foreigners who had lost confidence in the dollar and by domestic depositors who feared that the United States would go off the gold standard [14], which it did when President Roosevelt signed Executive Order 6102, The Gold Confiscation Act of April 5, 1933.[15]

According to a summary by the Congressional Research Service of the Library of Congress:

"In the nineteenth and early twentieth centuries, bankers and brokers were sometimes indistinguishable. Then, in the Great Depression after 1929, Congress examined the mixing of the “commercial” and “investment” banking industries that occurred in the 1920s. Hearings revealed conflicts of interest and fraud in some banking institutions’ securities activities. A formidable barrier to the mixing of these activities was then set up by the Glass Steagall Act."http://digital.library.unt.edu/govdocs/crs/permalink/meta-crs-9065:1]

First Glass-Steagall Act

The first Glass-Steagall Act was the first time that currency (non-specie, paper currency etc.) was permitted to be allocated for the Federal Reserve System.

Second Glass-Steagall Act

The second Glass-Steagall Act, passed on 16 June, 1933, and officially named the Banking Act of 1933, introduced the separation of bank types according to their business (commercial and investment banking), and it founded the Federal Deposit Insurance Corporation for insuring bank deposits. Literature in economics usually refers to this simply as the Glass-Steagall Act, since it had a stronger impact on US banking regulation.[16]

Impact on other countries

The Glass-Steagall Act has had influence on the financial systems of other areas such as China which maintains a separation between commercial banking and the securities industries.[17]

In the aftermath of the financial panic of 2008-9, support for maintaining China's separation of investment and commercial banking remains strong.[18]

References

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