What The Glass Steagall Act Was Finance Essay

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The Roaring Twenties was a decade of prosperity and financial boom. The Wall Street Crash of 1929 brought an end to this era and marked the beginning of the Great Depression. Prior to the Crash, a speculative bubble in the stock market kept increasing the price of stocks. Several Americans thought that investing in stock was the quickest and and surest path to prosperity. A significant number of investors had taken loans in order to purchase stock and defaulted on them when the stock market crashed. Banks themselves had heavily invested in the stock market. Unable to recover the money they had invested, several banks were forced to shut down. As news of banks shutting down spread, people panicked and began withdrawing money from the banks that were still functioning which further led to a series of bank runs throughout the United States. This caused even more banks to close and led to a nationwide banking failure. As Gailbraith (1954, P.196-7) notes, “When one bank failed, the assets of others were frozen while depositors elsewhere had a pregnant warning to go and ask for their money. Thus one failure led to other failures, and these spread with a domino effect”. Several economists, such as Krugman (2009) and Milton Friedman (1963) argue that it was the banking crisis that turned a recession into a depression. The Glass-Steagall Act (GSA) was an emergency response to the Wall Street Crash, the nationwide banking failure and the Great Depression. The GSA was sponsored by Senator Carter Glass and Representative Henry Steagall and passed by the US National Congress in 1933. It was a depression era regulation with two major provisions; the insurance of bank deposits and the separation of commercial and investment banking . Between 1929 and 1933, the United States witnessed a series of bank runs which eventually led to a a nationwide banking failure. The Federal Deposit Insurance Corporation (FDIC) was established by the GSA to provide deposit insurance in the event of such bank failures. By insuring deposits, the FDIC regained depositors’ trust in the banking system and virtually put an end to bank runs. In 1943, the FDIC insured deposits up to $2,500 per depositor. This amount increased over the years and is currently $250,000 per deposit. The GSA also created a regulatory firewall separating commercial and investment banking. This was done to protect deposits form risky investments. Any bank that accepted deposits could not trade in securities (with the exception of government bonds) and any bank that underwrote securities or engaged in speculating could not accept deposits.  As Krugman (2012, p. 59) explains, “any bank accepting deposits was restricted to the business of making loans; you couldn’t use depositors’ funds to speculate in stock markets or commodities, and in fact you couldn’t house such speculative activities under the same institutional roof”. The financial crisis of 2008 began with the bursting of the real estate bubble in the the United States and transformed into the worst recession the world has experienced since the Great Depression.

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