Home & Family Finance
Is the Future of Banking an 83-Year-Old Defunct Law?
/ April 28th, 2018
When the economy came crashing down in 2008 in the second-worst financial crisis in American history, there was no shortage of people and institutions to blame.
Whether you believed it was caused by the excesses of Wall Street, ordinary people who took out home loans they couldn’t afford, or the aggressive lenders who gave them shady loan products and then sold those loans to Wall Street—it was clear something needed to be done.
What is the Glass-Steagall Act?
One of the reforms debated this election cycle is reinstating an 83-year-old banking law called the Glass-Steagall Act, repealed in 1999.
The Glass-Steagall Act—named after the bill’s sponsors Senator Carter Glass of Virginia and Representative Henry Steagall of Alabama—is part of the Banking Act of 1933, passed by the government in response to the worst financial crisis in American history, The Great Depression.
The Banking Act of 1933 created the Federal Deposit Insurance Corp. that would guarantee consumer deposits. This is still in effect today. If a bank goes under, the government will give you any money you lost up to $250,000—that’s what FDIC insured means.
As part of that guarantee, the government included the stipulation, commonly referred to as the Glass-Steagall Act, that a bank couldn’t do both commercial and investment banking.
The government’s thinking was that a bank engaging in risky investments shouldn’t also do traditional banking services—such as loans, savings, and checking accounts—because the comingling of those activities exposes regular people far outside Wall Street to greater risk.
When politicians talk about “breaking up the banks,” this is what they mean. Bringing back the Glass-Steagall Act would force megabanks like Citigroup, JPMorgan Chase, and Bank of America to divide their consumer and investment functions into separate entities.
A bank engaging in risky investments shouldn’t also be offering ordinary citizens traditional banking services.
Did Glass-Steagall's repeal cause the recession?
For 66 years Glass-Steagall was the law of the land, until successful lobbying efforts by the banking and financial-services industries resulted in its repeal in 1999. Less than a decade later the Great Recession hit. Coincidence? Like most things, it’s not that simple.
Former chairman of the Federal Reserve and economist Ben Bernanke doesn’t think the Glass-Steagall Act would’ve prevented the recession. An analysis by The New York Times finds that the repeal of the Act likely worsened the recession, but would not have prevented it.
But maybe the politicians are looking at the wrong Great Depression-era piece of legislation? Because there is a decades-old act that’s stood the test of the time and provides an answer for anyone longing for a simpler, safer, and more benign way to bank.
The credit union alternative
One year after Glass-Steagall, Congress passed the Federal Credit Union Act in 1934. The bill created a national credit union system of nonprofit, cooperative credit unions, embracing a movement founded on thrift and peer-to-peer lending that was flourishing just as banks all over the country were shuttering.
Taxpayer funds have never been used to bail out a credit union in the U.S.
The credit union mission of people coming together to provide each other with affordable financial services has proven incredibly durable. In the wake of the 2008 financial crisis, credit union membership swelled, just has it had during the Great Depression—soaring past 100 million members in the U.S.
Consider the stability of credit unions:
- Taxpayer funds have never been used to bail out a credit union in the U.S.
- Between 2008 and 2012, almost four times as many banks failed as credit unions.
- When a credit union does fold, it normally means it’s been absorbed by a larger credit union. In any event, consumer deposits are insured up to $250,000 by the National Credit Union Association—just as banks are by the FDIC.
In a recent piece about the Glass-Steagall act, NerdWallet quoted an opinion by Nobel Prize economist Joseph Stiglitz written in the immediate aftermath of the recession. Stiglitz, referencing Glass-Steagall, wrote:
“Commercial banks are not supposed to be high-risk ventures; they are supposed to manage other people’s money very conservatively. It is with this understanding that the government agrees to pick up the tab should they fail. Investment banks, on the other hand, have traditionally managed rich people’s money—people who can take bigger risks in order to get bigger returns.”
That ideal commercial bank he’s describing—the one’s that’s people-focused, cares about the finances of ordinary Americans, and is careful with people’s money? Yeah, that’s a credit union.