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

In January of 1933 Ferdinand Pecora was appointed to the subcommittee. Subsequent to his appointment and his investigative efforts came the exposure of the corruption and scandalous practices of the investment banker (private) and the commercial banker. In April of 1933 the scope of the inquiry widened to make a thorough and complete investigation of the operations and business practices of private bankers as well. Common practices uncovered by the investigation included the following: reputable investment houses that pushed on unsuspecting investors the securities of a company in which they were closely associated; speculation on the stock exchange; and evasion of income taxes on huge earnings by investment bankers. These questionable activities were aided by the commercial banks as they advised their depositors to use their affiliates' security salesmen for investment advice. The disclosure of these abuses through Senate hearings and the press shocked the public and paved the way for government regulation.

IV

1933 Creation of Glass-Steagall

THE GRAY-PECORA INVESTIGATIONS' DISCLOSURE of unsavory practices such as tax evasion, stock speculation, and forced stock selling resulted in vehement public reaction. Given the disastrous condition of the financial system in the early 1930s, these disclosures were untimely, in that they perpetuated general distrust and shattered confidence in the system. Thus, as Carosso (1970) argues, the Glass-Steagall provisions were designed, in part, to restore public confidence in the banking system. As one scholar puts it: "the conspicuous abuses of the period 1927-1929 had made legislation of this [Glass-Steagall] sort politically necessary" (Anderson 1949:321). Thus, from a political standpoint, the Roosevelt administration was forced to implement changes in the investment banking field once the findings of the investigation became public knowledge.

A. Provisions of the Glass-Steagall Act

The term "Glass-Steagall Act" refers to those sections of the Banking Act of 1933 that deal specifically with investment activity within the commercial banking sector. Four sections of the Banking Act of 1933 were designed as a means of separating commercial from investment banking. Sections 16 and 20 prohibited national and state member banks from underwriting corporate equity and debt securities. National banks, state member banks, and their affiliates were prohibited from dealing in securities. However, for state, non-member banks, federal law constructed a legal wall between commercial and investment banking activities, prohibiting non-member banks from themselves engaging in certain securities activities, but not prohibiting their affiliation with securities activities (Symons and White 1984:433). Section 21 prohibited any financial institution engaged in deposit banking, including private banks, from underwriting securities, with several exceptions. These exceptions included U.S. government obligations, state or political subdivision obligations, or obligations issued under the authority of the Federal Farm Loan Act, the Federal Home Loan Banks, or the Home Owners' Loan Corporation (Banking Act of 1933, p. 185).