Due to the abuses of the 1920's, having to do specifically with over-leveraging and high risk debt instruments, the Federal Government issued regulations preventing Investment banks from issuing consumer credit AND access to the Fed discount window. The overwhelming evidence that Investment Banks are almost completely responsible for the current credit securities crisis cannot be overlooked. It is no wonder that they line their reserves with 1B assets while Commercial banks are instructed to hold more fiat money 1A.
In essence Glass-Steagall or "The Emergency Banking Act of 1933" prevented banks that would hold consumer deposits from brokerage functions as well as closed off the fed fiat money spigot. Simple, I-banks were supposed to be allowed to succeed or fail upon their own merits. This act, which protected the consumer market from over-leveraging and floating junk were slowly and deliberately dismantled:
1933:
Following the Great Crash of 1929, one of every five banks in America fails. Many people, especially politicians, see market speculation engaged in by banks during the 1920s as a cause of the crash.
In 1933, Senator Carter Glass (D-Va.) and Congressman Henry Steagall (D-Ala.) introduce the historic legislation that bears their name, seeking to limit the conflicts of interest created when commercial banks are permitted to underwrite stocks or bonds. In the early part of the century, individual investors were seriously hurt by banks whose overriding interest was promoting stocks of interest and benefit to the banks, rather than to individual investors. The new law bans commercial banks from underwriting securities, forcing banks to choose between being a simple lender or an underwriter (brokerage). The act also establishes the Federal Deposit Insurance Corporation (FDIC), insuring bank deposits, and strengthens the Federal Reserve's control over credit.
The Glass-Steagall Act passes after Ferdinand Pecora, a politically ambitious former New York City prosecutor, drums up popular support for stronger regulation by hauling bank officials in front of the Senate Banking and Currency Committee to answer for their role in the stock-market crash.
In 1956, the Bank Holding Company Act is passed, extending the restrictions on banks, including that bank holding companies owning two or more banks cannot engage in non-banking activity and cannot buy banks in another state.
Beginning in the 1960s, banks lobby Congress to allow them to enter the municipal bond market, and a lobbying subculture springs up around Glass-Steagall. Some lobbyists even brag about how the bill put their kids through college.
In the 1970s, some brokerage firms begin encroaching on banking territory by offering money-market accounts that pay interest, allow check-writing, and offer credit or debit cards.
1986-1987: GREENSPAN
In December 1986, the Federal Reserve Board, which has regulatory jurisdiction over banking, reinterprets Section 20 of the Glass-Steagall Act, which bars commercial banks from being "engaged principally" in securities business, deciding that banks can have up to 5 percent of gross revenues from investment banking business. The Fed Board then permits Bankers Trust, a commercial bank, to engage in certain commercial paper (unsecured, short-term credit) transactions. In the Bankers Trust decision, the Board concludes that the phrase "engaged principally" in Section 20 allows banks to do a small amount of underwriting, so long as it does not become a large portion of revenue. This is the first time the Fed reinterprets Section 20 to allow some previously prohibited activities.
In the spring of 1987, the Federal Reserve Board votes 3-2 in favor of easing regulations under Glass-Steagall Act, overriding the opposition of Chairman Paul Volcker. The vote comes after the Fed Board hears proposals from Citicorp, J.P. Morgan and Bankers Trust advocating the loosening of Glass-Steagall restrictions to allow banks to handle several underwriting businesses, including commercial paper, municipal revenue bonds, and mortgage-backed securities. Thomas Theobald, then vice chairman of Citicorp, argues that three "outside checks" on corporate misbehavior had emerged since 1933: "a very effective" SEC; knowledgeable investors, and "very sophisticated" rating agencies. Volcker is unconvinced, and expresses his fear that lenders will recklessly lower loan standards in pursuit of lucrative securities offerings and market bad loans to the public. For many critics, it boiled down to the issue of two different cultures - a culture of risk which was the securities business, and a culture of protection of deposits which was the culture of banking.
In March 1987, the Fed approves an application by Chase Manhattan to engage in underwriting commercial paper, applying the same reasoning as in the 1986 Bankers Trust decision, and in April it issues an order outlining its rationale. While the Board remains sensitive to concerns about mixing commercial banking and underwriting, it states its belief that the original Congressional intent of "principally engaged" allowed for some securities activities. The Fed also indicates that it will raise the limit from 5 percent to 10 percent of gross revenues at some point in the future. The Board believes the new reading of Section 20 will increase competition and lead to greater convenience and increased efficiency.
In August 1987, Alan Greenspan -- formerly a director of J.P. Morgan and a proponent of banking deregulation -- becomes chairman of the Federal Reserve Board. One reason Greenspan favors greater deregulation is to help U.S. banks compete with big foreign institutions.
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