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Glass–Steagall Act
Last week we saw the comments of ex Fed Chaiman Paul Volcker and in that he has mentioned this act. This week I am giving the general idea of the act so that my readers may understand the usefulness of this act. China’s success in keeping the depression away is attributed to this act and so I feel earnestly that we must also consider implementation of this act to protect ordinary people from the evasive activities of the gambling community using funds for speculative activities. An open discussion on the subject may be allowed to know more about the effects of this law on our economy. One thing we must not forget and that is, this act was introduced in 1933 and was repealed in 1999. During this period U.S. did not suffer from any serious depression. And as this law was repealed within a few years the measure depression U.S. had to face. This clearly shows the effectiveness of this law.
Two separate United States laws are known as the Glass–Steagall Act. Both bills were sponsored by Democratic Senator Carter Glass of Lynchburg, Virginia, a former Secretary of the Treasury, and Democratic Congressman Henry B. Steagall of Alabama, Chairman of the House Committee on Banking and Currency.
The second Glass–Steagall Act (the Banking Act of 1933) was a reaction to the collapse of a large portion of the American commercial banking system in early 1933. It introduced the separation of bank types according to their business (commercial and investment banking), and it founded the Federal Deposit Insurance Corporation for insuring bank deposits. Literature in economics usually refers to this latter act simply as the Glass–Steagall Act, since it had a stronger impact on US banking regulation.
"Rediscounting" is a way of providing financing to a bank or other financial institution. Especially in the 1800s and early 1900s, banks made loans to their customers by "discounting" their customers' notes (promissory notes). Such a note is a paper document, in a specified form, in which the borrower promises to pay a certain amount at a specified, future date. For example, assume that a customer wants to borrow $1000 for one year. In exchange for giving him $1000 today, the bank might ask him to sign a note promising to pay $1100 one year from now. The bank is "discounting" the note by giving the customer less than the note's $1100 face value. The extra $100 is the bank's compensation for providing the $1000 to the customer before the note matures. The Federal Reserve System could provide financing to the bank by "rediscounting" this note, for example, by giving the bank $1050 in exchange for the note.
In the nineteenth and early twentieth centuries, bankers and brokers were sometimes indistinguishable. Then, in the Great Depression after 1929, Congress examined the mixing of the “commercial” and “investment” banking industries that occurred in the 1920s. Hearings revealed conflicts of interest and fraud in some banking institutions’ securities activities. A formidable barrier to the mixing of these activities was then set up by the Glass Steagall Act.
The Act has influenced the financial systems of other areas such as China, which maintains a separation between commercial banking and the securities industries. In the aftermath of the financial panic of 2008–9, support for maintaining China's separation of investment and commercial banking remains strong.
The bill that ultimately repealed the Act was introduced in the Senate by Phil Gramm (Republican of Texas) and in the House of Representatives by Jim Leach (R-Iowa) in 1999. Under pressure from speculator’s lobby; as some banks (Bank of America) were in the grip of speculators, to resist the continuation of this act was alarming, the argument used was simple, for so many years we do not have any depression and so this act is not required! Unfortunately the act was repealed and the trouble again popped up its nasty head!
The argument for preserving Glass–Steagall (as written in 1987):
1. Conflicts of interest characterize the granting of credit — lending — and the use of credit — investing — by the same entity, which led to abuses that originally, produced the Act.
2. Depository institutions possess enormous financial power, by virtue of their control of other people’s money; its extent must be limited to ensure soundness and competition in the market for funds, whether loans or investments.
3. Securities activities can be risky, leading to enormous losses. Such losses could threaten the integrity of deposits. In turn, the Government insures deposits and could be required to pay large sums if depository institutions were to collapse as the result of securities losses.
4. Depository institutions are supposed to be managed to limit risk. Their managers thus may not be conditioned to operate prudently in more speculative securities businesses. An example is the crash of real estate investment trusts sponsored by bank holding companies (in the 1970s and 1980s).
However, under tremendous pressure of gambling lobby this act was finally repealed.
The repeal enabled commercial lenders such as Citigroup, which was in 1999 the largest U.S. bank by assets, to underwrite and trade instruments such as mortgage-backed securities and collateralized debt obligations and establish so-called structured investment vehicles, or SIVs, that bought those securities. Elizabeth Warren, author and one of the five outside experts who constitute "the Congressional Oversight Panel" of the “Troubled Asset Relief Program”, has said that the repeal of this act contributed to the Global financial crisis of 2008–2009. Misappropriation of huge funds for gambling became possible as this law was repealed. Funds of depositors were diverted for gambling and speculative activities in an unlimited way, finally leading to the crisis.
In mid-December of 2009, Republican Senator John McCain of Arizona and Democratic Senator Maria Cantwell of Washington State jointly proposed re-enacting the Glass-Steagall Act, to re-impose the separation of commercial and investment banking that had been in effect from the original Act in 1933, to the time of its initial repeal in 1999. Legislation to re-enact parts of Glass-Steagall was also introduced into the House of Representatives.
On January 21, 2010, Barack Obama proposed bank regulations similar to some parts of Glass-Steagall in limiting certain of banks' trading and investment capabilities. The proposal was dubbed 'The Volcker Rule', for Paul Volcker, who has been an outspoken advocate for the reimplementation of many aspects of Glass-Steagall and who appeared with Obama at the press conference in support of the proposed regulations.
A few American Banks are against the reintroduction of this law since it is against the interests of the gambling communities who control these banks. In India we have protectors of gambler society in the form of Manmohan Singh and Chidambaram and so I will not be surprised if the government refuses to introduce the Act in India! Manmohan Singh being the only Wise-man for Congress party.
In Mainland Europe, notably in France, Germany and Italy, an increasing number of think-tanks such as the CEE Council are calling for the adoption of stricter bank regulation through new national and EU-wide legislations based on the Glass-Steagall Act.
To explain the act in short, there will be two sets of banks. One will be called Commercial bank and that will manage usual banking activities they do but will not involve in any speculative activity such as shares, swaps, derivatives and more. Other bank will be called speculative bank (investment bank) ; this bank will exclusively handle all speculative activities, invest in new shares of companies, mortgage and all those businesses. The speculative bank will raise their fund by selling bonds and borrowing from pen market but will not any monitory relation directly or indirectly with any commercial bank. This arrangement will keep commercial banks from evasive and dangerous business deals of the speculative bank. With this separation is experienced that serious economic crisis are effectively avoided.
I want to know; if our Reserve Bank and the finance department of the ministry are going to do the same to protect the interests of the depositors or not?
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