Glass-Steagall Act

Definition

The Glass-Steagall Act was a U.S. law enacted in 1933 that separated commercial banking from investment banking activities to protect consumers and reduce the risk of financial speculation. This act was a response to the 1929 stock market crash and aimed to restore public confidence in the banking system by preventing banks from engaging in high-risk investments with depositors' funds.

5 Must Know Facts For Your Next Test

1. The Glass-Steagall Act was part of the Banking Act of 1933 and was a key component of the New Deal reforms initiated by President Franklin D. Roosevelt.
2. The act established the Federal Deposit Insurance Corporation (FDIC), which provides insurance for bank deposits to protect consumers in case of bank failures.
3. The separation of commercial and investment banking under the Glass-Steagall Act helped to mitigate the risks associated with speculative trading practices that contributed to the Great Depression.
4. The provisions of the Glass-Steagall Act were largely repealed in 1999 with the Gramm-Leach-Bliley Act, which allowed banks to re-enter investment activities.
5. Following the repeal, there was a significant increase in risky financial practices, which many analysts believe contributed to the financial crisis of 2008.

Review Questions

• How did the Glass-Steagall Act aim to protect consumers and restore confidence in the banking system after the Great Depression?
  • The Glass-Steagall Act aimed to protect consumers by separating commercial banking from investment banking, ensuring that depositors' funds could not be used for risky speculative investments. This separation was intended to restore public confidence in the banking system by creating a more stable financial environment where banks were less likely to engage in high-risk activities that could jeopardize customers' savings.
• What role did the Glass-Steagall Act play in shaping the regulatory framework of the U.S. financial system, especially regarding consumer protection?
  • The Glass-Steagall Act played a crucial role in shaping the U.S. financial regulatory framework by establishing clear boundaries between commercial banks and investment banks. By creating the Federal Deposit Insurance Corporation (FDIC) and enforcing strict regulations on banking practices, it enhanced consumer protection by safeguarding deposits and reducing the potential for conflicts of interest that could arise from banks engaging in both commercial and investment activities.
• Evaluate the impact of the repeal of Glass-Steagall on modern banking practices and its relation to financial crises, particularly looking at events leading up to 2008.
  • The repeal of Glass-Steagall through the Gramm-Leach-Bliley Act allowed banks to merge commercial and investment banking operations, leading to increased risk-taking behavior as banks sought higher profits through complex financial instruments. This shift contributed to a culture of speculation within the financial sector, culminating in the 2008 financial crisis. Analysts argue that the lack of separation between types of banking allowed institutions to engage in practices that magnified systemic risk, ultimately resulting in widespread economic fallout.

Related terms

Commercial Banking: A type of financial institution that accepts deposits, offers checking and savings accounts, and provides loans to individuals and businesses.

Investment Banking:

A financial service that assists companies in raising capital by underwriting and issuing securities, and providing advisory services for mergers and acquisitions.

Financial Crisis of 2008: A severe worldwide economic crisis that occurred in the late 2000s, marked by the collapse of large financial institutions due to exposure to subprime mortgages, leading to widespread economic downturn.