by The End of Depression-Era Banking Separation and the Road to 2008
Tearing Down the Wall: The End of Financial Compartmentalization
The repeal of the Glass-Steagall Act in 1999 via the Gramm-Leach-Bliley Act (GLBA) was one of the most consequential financial deregulations of the late 20th century, symbolically and structurally ending 66 years of legally enforced separation between commercial banking (taking deposits and making loans) and investment banking (underwriting securities, dealing, and proprietary trading). The original Glass-Steagall Act of 1933 was a direct response to the speculative excesses believed to have contributed to the 1929 crash and the subsequent bank failures. Its core provision, Section 20, prohibited commercial banks from being “engaged principally” in the business of “issuing, underwriting, selling, or distributing” securities. This wall was meant to protect taxpayer-insured deposits from the risks of Wall Street speculation and to prevent conflicts of interest. For decades, it defined the American financial landscape, creating distinct realms for firms like Citibank (commercial) and Morgan Stanley (investment). However, by the 1980s and 1990s, this separation was being eroded by regulatory loopholes, court rulings, and the competitive pressure of global universal banks. The GLBA, signed by President Bill Clinton, formally demolished the wall, allowing for the creation of financial holding companies that could own commercial banks, investment banks, and insurance companies under one corporate umbrella. Proponents hailed it as a necessary modernization; critics would later view it as a key milestone on the road to the 2008 financial crisis.
The Drive for Repeal: Globalization, Innovation, and Lobbying
The push for repeal was driven by powerful forces. 1. Global Competition: European and Japanese “universal banks” like Deutsche Bank and UBS operated without such restrictions, and U.S. firms argued they needed similar scale to compete globally. 2. Financial Innovation: New products like securitization and derivatives blurred the lines between loans and securities. Commercial banks were already engaging in securities-like activities through their trust departments and via loopholes. 3. The Citicorp-Travelers Merger: In 1998, in a bold act of corporate defiance, Citicorp (a commercial bank) announced a merger with Travelers Group (an insurance and investment banking conglomerate owning Salomon Smith Barney). This merger was illegal under Glass-Steagall but was allowed under a temporary waiver, creating massive pressure on Congress to change the law to legitimize the $70 billion deal. 4. Intensive Lobbying: The financial industry spent millions lobbying for repeal, arguing that consolidation would lead to greater efficiency, “one-stop shopping” for consumers, and enhanced stability through diversification. The political climate, influenced by the free-market ideology of the Reagan-Thatcher era and the booming 1990s economy, was receptive. The bill passed with broad bipartisan support.
The Immediate Aftermath: The Creation of Megabanks
The GLBA triggered a wave of consolidation that created the American financial behemoths of the 21st century. The Citicorp-Travelers merger was finalized, creating Citigroup, the world’s largest financial services company at the time. J.P. Morgan merged with Chase Manhattan, and later acquired Bank One, creating JPMorgan Chase. Bank of America acquired Merrill Lynch during the 2008 crisis. These new universal banks could now gather insured deposits, underwrite securities, trade derivatives, sell insurance, and engage in proprietary tradingall under one roof. They argued that this diversification would make them safer (“the portfolio effect”) and more efficient. In the short term, the repeal was followed by a period of profitability and innovation in financial products. However, it also concentrated risk and created institutions so large and interconnected that their failure would threaten the entire systemthe definition of “too big to fail.”
Link to the 2008 Financial Crisis: The Controversial Connection
The role of Glass-Steagall repeal in the 2008 crisis is fiercely debated. Proponents of repeal argue the crisis was caused by factors largely unrelated to the wall: reckless mortgage lending by non-bank originators (like Countrywide), flawed credit ratings on mortgage-backed securities, and excessive leverage across the entire shadow banking system, not just universal banks. They note that pure investment banks (Lehman Brothers, Bear Stearns) and insurance companies (AIG) were at the epicenter, not the depository arms of universal banks. Critics contend that repeal was a crucial enabler. It allowed commercial banks with access to cheap, insured deposits to fund and originate the risky mortgage-backed securities and complex derivatives that poisoned the system. It created conflicts of interest where banks would originate mortgages, package them into securities, sell them to investors (including their own clients), and sometimes bet against those same securities. The culture of conservative banking was infected by the high-risk, high-reward culture of investment banking. The repeal also fueled the growth of these mega-institutions whose sheer size and complexity made them unmanageable and unwindable, necessitating taxpayer bailouts. While not the sole cause, most analysts agree that repeal contributed to the crisis by increasing systemic risk, complexity, and conflicts of interest within the heart of the financial system.
Legacy: The Enduring Debate and Post-Crisis Reform
The legacy of Glass-Steagall repeal is a permanent schism in financial policy thought. It stands as the iconic symbol of pre-crisis deregulatory overreach. In the aftermath of 2008, there were loud calls to “bring back Glass-Steagall,” most notably in the 2016 presidential campaigns of Bernie Sanders and Donald Trump. While a full restoration did not happen, the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act included the “Volcker Rule” (Section 619), which prohibits insured depository institutions from engaging in proprietary trading and from owning or sponsoring hedge funds or private equity fundsa partial, albeit complex, reinstatement of the separation principle. The debate continues between those who believe large, diversified banks are essential for global competitiveness and those who believe they are an unacceptable concentration of risk and power. The repeal of Glass-Steagall represents a profound lesson in regulatory change: it demonstrates how laws born of one crisis can be dismantled in times of prosperity, often with unintended consequences that only become clear in the next crisis. It is a stark reminder that the architecture of finance is not just technical, but deeply political and philosophical, reflecting an eternal tension between innovation and stability, between Wall Street’s ambitions and Main Street’s security.
