The Repeal of the Glass-Steagall Act: Myth and Reality

By Oonagh McDonald,

The Glass-Steagall Act was enacted in 1933 in response to banking crises in the 1920s and early 1930s. It imposed the separation of commercial and investment banking. In 1999, after decades of incremental changes to the operation of the legislation, as well as significant shifts in the structure of the financial services industry, Glass-Steagall was partially repealed by the Gramm-Leach-Bliley Act.

When the United States suffered a severe financial crisis less than a decade later, some leapt to the conclusion that this repeal was at least partly to blame. Indeed, both the Republicans and the Democrats included the reinstatement of Glass-Steagall in their 2016 election platforms.

However, the argument that repealing Glass-Steagall caused the financial crisis, and that bringing it back would prevent future crises, is not supported by the facts. Glass-Steagall could not have prevented the bank failures of the 1920s and early 1930s had it been in force earlier, and wouldn’t have averted the 2008 financial crisis had it stayed in force after 1999.

Widespread Depression-era bank failures were primarily due to the fragility of the banking system at that time. Regulations that prohibited branch banking meant that America’s banks were frequently very small, with undiversified loan portfolios tied to the local economy of specific regions. Persistent crop failures and falling real estate values pushed thousands of these banks over the edge. Loan-financed securities speculation — the target of Glass-Steagall — had very little to do with it.

Likewise, during the recent financial crisis, commercial bank failures were largely driven by credit losses on real estate loans. The banks that failed generally pursued high-risk business strategies that combined nontraditional funding sources with aggressive subprime lending. Glass-Steagall would not have stopped any of this. Nor could it have stopped standalone investment banks, such as Lehman Brothers, from running into trouble.

Ultimately, those who see a simple solution to our contemporary financial woes in repealing Gramm-Leach-Bliley and reimposing Glass-Steagall only betray their misunderstanding of both pieces of legislation. The causes of financial crises — past, present, and future — lie elsewhere.

… by focusing the public’s anger on “greed,” “overpaid bankers,” and so-called “casino banking,” politicians have been able to divert attention from the ultimate cause of the financial crisis, namely their belief that affordable housing can be provided by encouraging — or even obliging — banks to advance mortgages to homebuyers with low to very low incomes, and requiring government-sponsored enterprises to purchase an ever-increasing proportion of such loans from lenders. If politicians continue to believe that affordable housing can only be provided in that way and act accordingly, no one need look any further for the causes of the next financial crisis.

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