Longstanding political battles have been fought over the banking system, its internal structure, and the investment habits of its largest members. The Glass-Steagall Act was enacted in order to fight on the side of depositors, aiming to protect them from risky investments, and remove the investment banking component from the commercial banking equation.
In 1999, the Clinton administration facilitated the repeal of the act, but the current Trump administration is proposing to reinstate it. Is Glass-Steagall coming back into play?
What is the Glass-Steagall Act
The Glass-Steagall Act was enacted in 1933 and provided a separation between investment and commercial banking. Now, after 20 years, the Trump administration is aiming to revive it. The original Glass-Steagall Act was enacted in 1933 in an effort to prohibit traditional banks from pursuing risky investments.
In 1999, Congress repealed the act, allowing banks to flourish and become large presences that can also participate in selling stocks and bonds. Critics believe that the original repeal of the original law contributed to some speculative lending and investment practices that led to the great recession in 2007.
After the recession, calls for the law have risen in order to help protect depositors from risky investments made by their banks. Big banks such as JPMorgan Chase, Bank of America, and Citigroup benefitted greatly from the dismissal of the Glass-Steagall Act.
Investment banking opened up horizons and allows them to invest freely and build enormous corporations on investments that were more lucrative – and risky – than they could have been while Glass-Steagall was active.
Why the Trump administration is proposing reinstatement
Instead of breaking down big banks, this modern version would aim to restructure banks and instill the application of protective measures. This 21st Century version of Glass-Steagall would aim to prevent banks from acting as both commercial lenders and investment banks, and force them to revamp their internal structures to reduce risk.
The Trump administration hints that this reprise would be a much more relaxed version of its 1933 counterpart and focus more on managing the investment activities of banks, requiring them to add capital to protect losses, and partition commercial and investment banking activities to protect depositors.
Many individuals believe that such protections help prevent economic recessions by instituting checks and balances that prevent the need for big bank bailouts and a country full of depositors left in the lurch.
The reinstatement of the Glass-Steagall Act has plenty of momentum. Trust in big banks is still pitifully low, and a strong skepticism remains in terms of the nation’s perception of big banks. The Trump administration is well-positioned to capitalize on this skepticism and win favor for the future election by giving a nod towards reinstatement of better controls over the banking system.
What does this mean for the investment community?
A repeal of Glass-Steagall allowed banks to expand their services and handle investments, insurance and deposits. It allowed investments to move beyond the walls of Wall Street and provided regional banks the ability to expand operations and provide their customers with additional investment options.
But banks are meant to invest in only conservative investments, and such a repeal would also open the door for banks to pursue risky behaviors that could land them in deep water, creating another nationwide financial crisis.
And the separation of commercial and investment banking can help reduce volatility in the securities markets and help depositors avoid conflicts of interest. But bank investments are significant and can help feed the stock market.
Without Glass-Steagall, banks can be more competitive and beat out foreign financial firms.
Bank monitoring and better internal banking structure is something that both democrats and republicans seem to be able to agree on. Avoiding another situation where banks become “too big to fail” and put the financial health of the nation at risk affects Main Street on both sides of the debate.
It may not be fully in view, but a reprise of the Glass-Steagall Act or a similar effort may be glistening on the nation’s political horizon. This direction would put safeguards in place for the nation’s depositors who have been burned by the risky actions of our nation’s biggest banks.
But separating commercial and investment banking does come with its own set of consequences. It remains to be seen whether any part of Glass-Steagall returns to the playing field, but in a nation full of untrusting depositors, it would come with plenty of support.