Glass-Steagall Act of 1933

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Severe problems in the money markets were readily visible in the 1920s, but the prevailing economic prosperity blinded most Americans to the looming catastrophe. More than 5,600 banks failed during the 1920s, primarily because of undercapitalization, over competition, real-estate speculation, and corporate venality, and the stock market rocketed to new heights based more on mindless euphoria than on sound company profits. In the process, the line between commercial banking and investment banking grew perilously thin, with the money of millions of depositors leaking into stock and bond accounts of Wall Street securities affiliates. The stock market crash of October 1929 created a liquidity crisis of unprecedented proportions, leading to the meltdown of 1932 to 1933, when the nation's banking system finally collapsed. Senator Carter Glass of Virginia and Representative Henry Steagall of Alabama proposed reform legislation, but the outgoing Herbert Hoover administration refused to act. In 1931, Congressman Ferdinand Pecora had launched an investigation of the banking system, setting the stage for reform legislation.

In March 1933, with President Franklin D. Roosevelt recently inaugurated, Glass and Steagall found more support in the White House. By then, of course, the crisis demanded action. The president had declared a nationwide banking holiday, shutting down every bank in the country and assuring Americans that only sound banks would reopen. He also promised reforms in the banking system that would prevent future systemic catastrophes in the money markets. During the famous first "One Hundred Days" of the Roosevelt administration, Glass and Steagall resubmitted the legislation. Both houses of Congress passed the measure in mid-June, and on June 16, 1933, President Roosevelt signed it into law.

The Glass-Steagall Act, also known as the Banking Act of 1933, formally separated investment banking and commercial banking and prohibited individual banks from engaging in both. Each institution had to declare itself either a commercial bank or an investment bank, and commercial banks had one year to divest themselves of securities affiliates. To prevent panic-stricken depositors from making runs on banks and forcing them into bankruptcy, the law established the Federal Deposit Insurance Corporation (FDIC) to guarantee individual bank accounts. To limit the possibilities of external manipulation of domestic money markets, the legislation also handed over control of the foreign operations of all Federal Reserve member banks to the Federal Reserve Board. Commercial banks were allowed to underwrite the securities only of state and local governments. Finally, the measure tightened Federal Reserve control over bank credit and provided more careful coordination of Federal Reserve open market operations. The Banking Act of 1933 helped restore confidence and liquidity to the money markets.



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