The Long and Bumpy Road to Glass-Steagall Reform: A Historical and Evolutionary Analysis of Banking Legislation - Other Articles - Glass-Steagall Banking Act of 1933

American Journal of Economics and Sociology, The, Oct, 2001 by Jill M. Hendrickson

State banks took advantage of profitable securities operations and by 1929, 356 state banks were engaging in securities business, either directly or through affiliates, as compared to 205 in 1922 (Litan 1987). In an attempt to level the playing field, national banks were allowed to underwrite securities approved by the Comptroller of the Currency under the McFadden Act in 1927. In 1926 approximately 1,100 national banks were active in securities dealings via state chartered affiliates. By 1930 the number rose to 1,900. In dollar terms, national banks' securities dealings amounted to $1 billion in mid 1928 and $4.5 billion in 1930 (Krooss and Blyn 1971:155). Thus the McFadden Act significantly increased the role of the national banks within the field of securities activities.

The post-war period gave additional energy to securities activity as stocks and bonds became extremely profitable investments. The war brought with it the widespread sale of Liberty Bonds. These Liberty Bonds were distributed primarily through commercial banks and created a crowd of investors in men and women who had previously saved through deposit institutions. The new wave of investors often turned to their bankers for investment advice, increasing the bank's exposure to the security-buying public and further sparking the commercial banker's interest in investment banking (Preston and Finlay 1930a). Additionally, business's investment strategy turned away from bank borrowing and toward open-market commercial paper and securities to finance investment projects. These changes in business activity encouraged the financial intermediaries' involvement in securities dealings. However, the infamous stock market crash of 1929 and its subsequent financial panic caused profitability to plummet, thereby reversing the tide of rising securities activity.

The quality of securities offered to the public also changed dramatically in the late 1920s as a result of the changing nature of securities dealings. Anderson (1949) argues that banks had a positive record in investment dealings through 1927 for two reasons. First, most banks and investment affiliates did not put their names upon issues so neither the banks' nor the investment affiliates' reputation were at risk. Second, the investment affiliates were able to keep organizational costs low because they had no retail sales organization. With the establishment of high-pressure sales organizations and selling issues bearing the banks' names, there was immense pressure to provide securities, regardless of the quality. According to Anderson, this development was an important factor in the deterioration of the quality of the new securities offered for public purchase.

In addition to falling profitability and quality within the securities field, another development contributed to the demise and eventual regulation of securities dealings: the Gray-Pecora investigation. Under the instruction of President Herbert Hoover, the investigation began in March of 1932. Initially, the Senate Banking and Currency Committee or one of its subcommittees was directed to make a thorough and complete investigation of buying and selling practices as well as borrowing and lending of securities upon the stock exchange. The findings of the subcommittee's effort (fraud and deception by investment firms) damaged the reputation of the investment bankers.