Why Megabanks Fear the Return of Glass-Steagall: QuickTake Q&A

Why Reinstating Glass-Steagall Would Increase Risk

Would the world be a safer place if banks came in two flavors -- dull but safe versus exciting but risky? That was the idea behind a law adopted in the U.S. during the Great Depression known as Glass-Steagall. But that tenet was undone in 1999, a move that’s been blamed by some for the 2008 market crash. Bringing that system back has won the support of politicians as diverse as President Donald Trump and Senator Elizabeth Warren, the Massachusetts Democrat who’s been one of Wall Street’s toughest critics. During the campaign, Trump called for a "21st century” version of Glass-Steagall and repeated in May that he’s considering going "back to the old system." But there’s plenty of opposition, and not just among Republicans. Some critics think going back is impossible or prohibitively disruptive. Some think the old rules miss the point of where the risks in the system now lie.

1. What was Glass-Steagall?

Passed in 1933, the Glass-Steagall law essentially split banking into two categories: deposit-taking companies backed by taxpayers that primarily made loans to businesses and consumers, and investment banks and insurers that traded complex securities, managed initial public offerings of companies and created bonds out of mortgages and auto loans. The Great Depression was triggered by the popping of a stock market bubble stoked by overleveraged investors who had borrowed heavily from banks to buy shares. Walling securities trading off from lending would prevent deposits from flowing into more volatile capital markets, Congress reasoned.

2. How well did that work?

It caused some upheaval on Wall Street. For instance, it forced J.P. Morgan & Co. to split off its investment bank, named Morgan Stanley. The big plus: Wall Street banks certainly had their share of ups and downs during the decades the law was in effect, but they didn’t cause any systemic financial meltdowns, a fact many observers credited to the law.

3. Why was it repealed?

The strict separation of deposit-insured banking and securities trading began to erode in the 1980s and 1990s. Regulators interpreted the law as allowing commercial banks to start underwriting complicated derivatives and dabble in other securities businesses. Banks also argued in the ’90s that they would fall behind in global competition if they couldn’t offer a full range of financial services to their clients, as their European or Asian rivals did. In 1998, the merger of Citicorp and Travelers Group created a megabank, Citigroup, whose services spanned insurance, capital markets and checking accounts. The merger and heavy lobbying by big banks led Congress to repeal the main tenet of Glass-Steagall in 1999.

4. Did that cause the 2008 crash?

The verdict on that is mixed. Glass-Steagall opponents say several of the firms that failed in the 2008 crisis -- Bear Stearns & Co., Lehman Brothers Holdings Inc., Merrill Lynch & Co. -- were stand-alone investment banks not backed by deposit insurance, while others, Wachovia and Washington Mutual, were standalone commercial banks, and thus not affected by the law. Others say repeal led investment banks like Lehman to make riskier bets as they struggled not to lose market share to the new megabanks, whose depositors gave them a cheaper source of funding.

5. What are the arguments for bringing Glass-Steagall back?

That it would limit deposit insurance to banks concentrating on making loans to companies and consumers -- businesses that might get into trouble but are not as likely to bring the whole system down with them. Drawing a clear line around investment banks would make it easier to allow them to fail. The government would be able to limit its backing to insured deposits only. Trump officials, including Treasury Secretary Steven Mnuchin and National Economic Council Director Gary Cohn, have offered support for bringing back some version of Glass-Steagall, though they’ve offered scant details on an updated approach. Both Mnuchin and Cohn are former bankers who worked for Goldman Sachs Group Inc.

6. What are the arguments against?

Restoring Glass-Steagall would mean breaking up the nation’s largest financial institutions. While that might be politically popular, opponents say the vast costs of doing so would not only hurt those banks but harm the economy by disrupting lending and capital markets. Others point out that reinstating the law’s separations wouldn’t have much effect on big investment banks or on insurers and money-market funds and other firms that are sometimes called shadow banks -- performing some banking functions outside the bank regulatory apparatus. Within the industry, bankers argue that U.S. firms wouldn’t be able to compete against global rivals who don’t face such restrictions. Chinese banks would take their place if U.S. megabanks are forced to break up, JPMorgan Chase & Co. Chairman and Chief Executive Officer Jamie Dimon has said.

7. Who was Glass-Steagall?

Two people, actually. One was a Democratic senator from Virginia named Carter Glass. The other was a Democratic House member from Alabama named Henry Steagall.

Reference Shelf

  • A QuickTake explainer on “too big to fail” banks.
  • A 2016 Congressional Research Service report on the debate over Glass-Steagall.
  • A Federal Reserve page on the history of Glass-Steagall.
  • A PBS Frontline report on the lobbying that led to Glass-Steagall’s repeal.
  • A 2012 Bloomberg News article on Sanford “Sandy” Weill’s change of heart on Glass-Steagall.
  • A 2006 Bloomberg News article on investment banks worrying about falling behind deposit-backed megabanks.
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