Bank History: A business and economic review (part two)
In 1933, in the wake of the 1929 stock market crash and during a nationwide commercial bank failure and the Great Depression, two members of Congress put their names on what is known today as the Glass-Steagall Act.
As a collective reaction to one of the worst financial crises at the time, the Glass-Steagall Act set up a regulatory firewall between commercial and investment banking activities, both of which were curbed and controlled. Banks were given a year to decide on whether they would specialize in commercial or in investment banking. Only 10 percent of commercial banks’ total income could stem from securities; however, an exception allowed commercial banks to underwrite government-issued bonds. Financial giants at the time such as JP Morgan and Company, which were seen as part of the problem, were directly targeted and forced to cut their services and, hence, a main source of their income. By creating this barrier, the GSA was further aiming to prevent the banks’ use of deposits in the case of a failed underwriting job.
Because of the then-lax-implementation of the GSA by the Federal Reserve Board, the regulator of U.S. banks, in 1956 Congress made another decision to regulate the banking sector. In an effort to prevent financial conglomerates from amassing too much power, the new act focused on banks involved in the insurance sector. Congress agreed then that bearing the high risks undertaken in underwriting insurance was not good banking practice. Thus, as an extension of the GSA, the Bank Holding Company Act further separated financial activities by creating a wall between insurance and banking. Even though banks could, and still can, sell insurance and insurance products, underwriting insurance was forbidden.
The limitations of the GSA on the banking sector then began to spark a debate over how much restriction was healthy for the industry. Consequently, to the delight of many in the banking industry, in November of 1999 Congress repealed the GSA with the establishment of the Gramm-Leach-Bliley Act under the Clinton Administration, which eliminated the GSA restrictions against affiliations between commercial and investment banks. Furthermore, the Gramm-Leach-Bliley Act also allowed banking institutions to provide a broader range of services, including underwriting and other dealing activities.
While many political pundits are now suggesting that President Obama, in his recent comments requesting new taxes and more regulations on the banking industry in populist retaliation aimed at those banking executives who have, both “arrogantly and insensitively,” paid themselves substantial bonuses in return for now record or near-record profits (thanks in large part to taxpayer-funded “bailout” money); others say that his proposed new regulations and taxes on the banking industry don’t go far enough and, indeed, may actually be counter-productive. Indeed, other political news commentators, as well, have also reported that the President’s suggestions didn’t go as far as those recommended by his financial advisor, former Fed Chairman Paul Volcker, whose suggestions were more in line with those of the now-repealed GSA.
With the GSA working quite well for 66 years, perhaps it’s now a better action for the Congress to re-enact the GSA to more effectively address the national (and even international) economic crisis, stabilize our country’s economy, afford small businesses with the ability to begin to grow again, and create and hire more employees, while in the process finally start to whittle down our current 10-percent-plus national unemployment rate. The lessons of the past can serve us well, if we use them or reuse them when necessary.
Paul Rendine is a financial advisor with over 30 years of experience. He can be contacted at his e-mail address at quoteman3@aol.com with any comments or questions.