Glass-Steagall Act
In the United States, the Glass-Steagall Act was a major banking law passed by the 73d Congress in 1933 and incorporated as part of the Banking Act of 1933. It was sponsored by Senator Carter Glass (D-VA) and Representative Henry B. Steagall (D-AL). The Banking Act of 1933 was also sponsored by Glass and Steagall and sometimes also goes by the name "Glass-Steagall Act." Glass and Steagall sponsored banking legislation in 1932 which also goes by the name "Glass-Steagall Act" (see Glass-Steagall Act of 1932). But what is colloquially known as the "Glass-Steagall Act" was separate legislation that was later added as sections 16, 20, 21, and 32 to the Banking Act of 1933.
Background
During the "Hundred Days" session of the 73rd Congress, major reforms of the U.S. banking system were sought. A major contributor to the lack of confidence in banks were the permissible activities of banks. Prior to this legislation, U.S. banks were permitted to loan money to any person or entity they wished. Banks, of course, continued to engage in commercial operations, holding demand deposits and making consumer loans. These were mostly mortgages, but 1920s saw the creation of the consumer credit market as middle-class consumers used credit to purchase automobiles and appliances.
Bank also were the source for large investment loans as well. When a manufacturer needed many millions for expansion of plant or to underwrite an initial public offering, they could turn to the banks as well. Also during the 1920s, banks loaned much to brokerage houses and otherwise directly pledged their reserves in the stock market.
These activities are inherently risky, and if a manufacturer can not repay, the default could force a bank to close. The most striking example of this failure was the Bank of the United States which failed in 1930 the result of having used its depositor moneys as investments in the stock market. Once a bank failed because of these risky investments, small depositors lost their money.
Provisions
The Glass-Steagall Act forced banks to choose their industry: either they would be commercial banks focusing on demand deposits or they would be investment banks underwriting higher risk investments. Banks in one area of business were forbidden from engaging in the other, except that commercial banks were permitted to underwrite securities of the U.S. government, states, or municipalities.
Banks were still permitted to offer investment advice and to buy and sell securities on behalf of their customers, but any information gathered in the process of these activities could not be used in establishing the credit-worthiness of customers.
Investment banks were prohibited from soliciting deposits.
Effect
The Glass-Steagall Act and the Banking Act of 1933 of which it is a part went a long way to restoring public confidence in the U.S. banking system. Americans began returning their money to their bank deposits which meant that banks had more money to lend.
Later History
The Glass-Steagall Act mostly remains in the U.S. code. Congress has from time to time altered the provisions of the law and have relaxed its regulation. The most important change to Glass-Steagall was the Gramm-Leach-Bliley Act of 1999 which repealed sections 20 and 32 of the Banking Act (specific provisions of Glass-Steagall). Banks can now offer brokerage services and underwrite certain types of securities previously forbidden by Glass-Steagall.