Glass-Steagall/Gramm-Leach-Bliley

Andrew Pape

Agenda

• History and lead up to Glass- Steagall• About Glass-Steagall (Banking Act of 1933)• Unwinding of Glass-Steagall• Gramm Leach Bliley Act

History

• During the 1920’s commercial banks became heavily involved in the stock market

• Speculation ruled• Stock market crashed in October 1929• By 1933 11,000 banks had either failed or had

to merge

Pecora Commission

• Began March 4th, 1932• Purpose was to

investigate the causes of the 1929 stock market crash

• Concluded that conflicts of interest between commercial and investment banking contributed to the crash.

Pecora Commission cont.• Common ownership of

commercial and investment banks created problems including– Jeopardizing depositors by

investing their money in the stock market

– Loss of the public’s confidence in banks, which lead to bank runs

– The making of unsound loans– Inability to provide honest

investment advice to depositors because banks were conflicted by their underwriting relationship with corporations

Conflicts of Interest played out

• Banks were investing customers deposits in securities they underwrote

• Unsound loans were made to improve the price of securities or the financial position of a company in which the bank had invested its own assets

• Banks persuaded their customers to invest in securities they were under pressure to sell.

http://www.thefreemanonline.org/featured/the-rise-and-fall-of-glass-steagall/

Provisions of Glass-Steagall

• Established Regulation Q– Limited interest rate banks paid depositors

• Separated commercial and investment banking

• Established the FDIC• Allowed Federal Reserve Board to vary reserve

requirements as it wished

Arguments against Glass-Steagall

• Glass-Steagall restrictions were becoming obsolete• Financial deregulation in foreign countries put

American institutions at a competitive disadvantage• Domestic firms would take capital abroad• Banks are losing market share to strictly regulated

independent securities firms • Conflicts of interest can be prevented by enforcing

regulation against them • Combinations of commercial and investment banks

would lead to diversification, decreasing overall risk

An Era of Deregulation

• Banks began lobbying congress in the 1960’s to loosen the restrictions under Glass-Steagall

• In 1986 Congress reinterpreted Glass-Steagall for the first time, allowing banks to derive 5% of gross revenues from investment banking

• In 1987, the Fed allowed banks to handle commercial paper, municipal bonds, and mortgage backed securities

Turning Point

• In 1998 banking behemoth Citicorp and insurance giant Travelers group merged.

• GLB had not passed yet. Citigroup had between 2-5 years to divest prohibited assets.

• Executives of Citigroup were confident that full repeal of Glass-Steagall would come soon.

http://banking.senate.gov/conf/

Provisions of Gramm-Leach-Bliley

• Allows securities firms and insurance companies to purchase banks

• Banks allowed to underwrite insurance and engage in real estate activities

• OCC regulates bank subsidiaries engaged in securities underwriting

• Fed oversees bank holding companies under which all real estate, insurance and large securities operations are housed

Phil Gramm’s take

• "The hallmark of the bill is that it will make an array of financial services available to every American consumer that will provide lower prices and one-stop shopping at financial supermarkets in every city and town in the country.

Financial Services Industry post Glass-Steagall

• Some large banks merging with securities market institutions to increase economies of scale (e.g. Chase and J.P. Morgan)

• In general much more overlap between banks and securities market institutions

Harbinger of evil?

Sources

• http://banking.senate.gov/prel99/1022fsm.htm• http://en.wikipedia.org/wiki/Citigroup#Citicorp

_and_Travelers_merger• http://law.jrank.org/pages/7165/Glass-Steagall-

Act.html• http://firedoglake.com/2009/06/17/pecora-in-p

erspective-a-glossary-of-useful-terms/• http://www.thefreemanonline.org/featured/

the-rise-and-fall-of-glass-steagall/• http://www.openthegovernment.org/sites/

default/files/otg/dereg-timeline-2009-07.pdf