Glass-Steagall Banking Act

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In the early 1900s, commercial banks established security affiliates to underwrite securities, such as stocks and bonds. A commercial bank is an institution that accepts demand deposits, such as a check, and makes commercial loans. Underwriting is the bank's guarantee to furnish a definite sum of money by a certain date to a business or government entity in return for the entity's issue of bond or stock. Commercial banks were heavily involved in securities underwriting until the 1929 stock market crash.

In 1930 the Bank of the United States failed, allegedly because of the activities of its security affiliates. In 1933 all banks nationwide closed for four days because of the Great Depression. Four thousand of these banks never opened again. This apparent collapse of the U.S. financial structure eroded public confidence that was already shaken from the hard times of the Depression. The failure of so many banks in such a short time frame was a fearful symbol to the public.

Responding to the public's lack of confidence in banks, President Franklin Roosevelt (19331945) proposed the Glass-Steagall Act as part of his New Deal program. Also known as the Banking Act of 1933, Glass-Steagall prohibits commercial banks from engaging in the investment business. Initially an emergency measure, the Act became permanent in 1945.

The Glass-Steagall Act established tighter regulation of national banks by the Federal Reserve System and created the Federal Deposit Insurance Corporation, which insures bank deposits with a pool of money supplied by the banks. It also prevented commercial banks from underwriting securities, except for a limited number of asset-backed securities, such as corporate bonds and U.S. Treasury and federal agency securities. The underwriting of securities was now almost strictly left to investment banks, which are unable to accept deposits. Investment banks are also authorized to set up corporate mergers, acquisitions, and restructuring, and provide brokers or dealers in investment transactions.

Succeeding legislation has relaxed the initial tenets of the Act. Commercial banks may now offer advisory services to customers regarding investments and buy and sell securities for them. Any information gathered through advisory services, however, can not be used by the bank when it acts as a lender.

See also: Federal Deposit Insurance Corporation, Great Depression, New Deal, Stock Market Crash of 1929