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February S, 1982
Glass-Steagall
In the past decade, distinctions have become
blurred between commercial banks and
other depository and nondepository institutions. Financial and Congressional figures
thus have begun to debate the half-centuryold piece of legislation which put those
distinctions into practice-the Glass-Steagall
Act (the Banking Act of 1933). Several bills
now before Congress would modify the Act
in different ways-for example, by permitting banks, either directly or through bank
holding-company subsidiaries, to undelWrite
municipal-revenue obligations and to offer
money-market funds. Such proposals also
would permit commercial banks to enter
certain restricted or prohibited areas-such
as investment advice, leasing, insurance,
data processing, and real-estate development
and brokering. Other issues arising from the
Glass-Steagall Act are also coming under
scrutiny-such as interstate banking, payment of interest on demand deposits, and the
structure ofthe Federal Reserve System. For
all these reasons, it would be worthwhile to
review the principal provisions of the Act and
the circumstances which led to their
adoption.
Genesis of Act
President Roosevelt signed the Banking Act of
1933 into law on June 16, 1933, after a twoyear-long period of Congressional hearings
and studies. The Act was authored by Senator
Carter Glass (D. Va.) and Congressman
Henry Steagall (D. Ala.), the chairmen of the
Senate and House Banking Committees.
,
Glass-Steagall was a child of the Great
Depression, and specifically reflected a Congressional response to the demise of some
1 0,000 banks between the crash of 1929 and
the imaginatively-named BankHoliday of
1933. In their reports, however, the Congressional Banking Committees blamed these
problems primarily upon developments
arising out of the prosperous 1920s. These
included an excessive increase in bank credit
for speculative purposes, especially loans to
brokers and the public for carrying securities,
which had been facilitated by a substantial
buildup of surplus reserves resulting from
large gold imports and Federal Reserveoperations. The Committees also blamed the
breakdown upon the growth of bank affiliates
("the greatest danger"), which "devote themselves in many cases to perilous undelWriting
operations, stock speculation, and maintaining a market for the banks' own stock,
often largely with the resources of parent
banks."
Key provisions
In an attempt to assure the safety and soundness of the banking system, Congress through
Glass-Steagall provided a clear separation
between commercial and investment banking-and between banking and commerce
generally. Specifically, Section 16 stipulated
that nationally-chartered banks be limited to
purchasing and selling investment securities
"solely upon the order, and for the account
of, customers and in no case for their own
account". That section, however, imposed no
restrictions on undelWriting and dealing in
U.s. government obligations, Federal agency
issues, and general obligations of state and
local governments. (Section S extended the
Glass-Steagall prohibitions from nationallychartered banks-which must be Federal Reserve members-to state-chartered member
banks as welL) On the other hand, Congress
excluded municipal-revenue obligations
from the laundry list of securities eligible for
acquisition, and the courts have interpreted
that exclusion as an implicit prohibition of
such activities-thereby complicating life for
many institutions today which would like to
deal in such securities.
Regarding boundary lines between institutions, Section 11 of the Act prohibited any
member bank from acting as an agent for any
non-banking entity in making loans to brokers or dealers in stocks, bonds, and other
investment securities. To resolve any doubts,
Section 20 further stipulated that no member
bank could be affiliated "with any corpor-
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expressed in this newsletter do not
reflect lhe views of the rnanagernent
of the Federal Reserve Bank of San Francisco,
or of the Board of Governors of thc' Feden'll
ReservE'Svstem.
ation, association,businesstrust, or similar
believed that the prohibition, by reducing
costs, would induce banks to avoid risky
high-yielding investments, and would also
make them better able to pay the premium on
deposit insurance required under another
provision of the Act However, many studies
have questioned the argument that payment
of interest on demand deposits had contributed to the widespread bank failures of the
early 1930s. The siphoning-of-funds argument, for example, overlooked the fact that
the typical rate on bankers' balances, at about
two percent in the 1920s, was less than the
5-to-5V, percent average rate of return on
bank portfolios at that time.
organization engaged principally in the issue,
flotation, undelWriting, public sale, or distribution at wholesale or retail, or through
syndicate participation, of stocks, bonds,'
debentures, notes, or other securities." The
bill's authors recognized the difficulty of
separating member banks completely from
financial affiliates of various types, but required that the examination of remaining
affiliates be carried out in a manner "as consistent as possible" with the examination of
parent banks. Congress subsequently expanded these restrictions considerably by
bank holding-company legislation.
Geographic restrictions
Further, Section 21 prohibited anyone in the
securities business from receiving deposits
subject to check "or repayment upon presentation of a passbook, certificate of deposit,
or evidence of debt" This constraint may
raise questions about the activities of today's
money-market mutual funds, which hold
about $185 billion in customer accounts with
check-writing privileges. These accounts,
however, technically represent shares and
not deposits, and thus do not come under
Glass-Steagall restrictions.
Finally, Glass-Steagall got into an area which
even now, a half-century later, isa matter of···
intense controversy-interstate banking. The
Act specifically amended the McFaddenPepper Act of 1927 to allow (national and
state-chartered) Federal Reserve member
banks to branch wherever state-chartered
nonmember banks could do so. Ironically,
the McFadden Act had been considered a
liberalizing measure, since it eased certain
branching restrictions on member banks.
Nonetheless, until 1 933,it still prohibited any
member bank, even in stateswhich permitted
state-wide branching, from establishing new
branches outside the parent (home office)
city, and it required any new member to
divest itself of any branches established
outside of the home-office city after passage
of the Act
Payment of interest
In another move to enhance the "safety and
soundness" of the banking system, GlassSteagall's Section 11 provided that no
member bank "directly or indirectly, by any
means whatsoever, shall pay any interest on
any deposit which is payable on demand."
(Congress later extended this restriction to
non-member banks under the Banking Act of
1 935.) N OW accounts and "other checkable
deposits", which amounttoabout $75 billion
today, do not fall under this prohibition
because most such accounts technically are
considered savings deposits under the terms
of the Monetary Control Act of 1 980.
The period between the passage of the
McFadden and Glass-Steagall Acts provided
a good laboratory experiment of the health of
branch-banking systems. The best example
came from the San Francisco (Twelfth)
Federal Reserve District, where branch
banking was quite common and where
several states permitted statewide branching.
This district accounted for less than five
percent of the 1 0,000 bank failures of the
1929-33 Depression, and only a few ofthe
Western branch systems succumbed during
this period. (In 1 929, only 64 of the 1 ,333
Western banks were branch systems, but they
The authors of the Glass-Steagall Act utilized
several different arguments in supporting a
prohibition on demand-deposit interest They
believed that large banks'paymentof interest
on "bankers' balances" in the 1920s had
siphoned funds from rural areas. Again, they
2
accounted for over 40 percent of all banking
offices in the district.)
together. The consumer clearly benefitted
from this competition between giant concerns. Moreover, through the cooperative
mechanism of franchising, such cards and
theirsuctessors have become important marketing tools for small depository institutions
which are unable to support the heavy costs
of developing and marketing cards on their
own. Today, with electronic transfers of funds
growing rapidly, the implications of anti-trust
policy regarding joint ventures assume great
significance forthe competitive viability
of financial institutions offering paymentsrelated services.
In view of the relative strength of branchbanking systems during the Depression era,
several Congressmen included a provision in
an earlydraftofthe 1933 bill that would have
permitted a national bank to establish
branches in an adjacent state within 50 miles
of its home office. However, Congress deleted the provision in the final mark-up of the
measure because of the strong opposition of
unit bankers and most state banking authorities. Congress also rejected a similar provision in the Banking Act of 1 935 that would
have allowed branch banking on a regional
or economic-area basis.
Another unresolved issue concerns the question of Federal versus state and local control.
Congress is now under pressure to assert an
overriding Federal interest in certain areas,
such as in proposed legislation for a Federal
preemption of state usury laws and of state
legal rulings regarding mortgage "due on
sale" clauses. In the opposite direction,
Congress is under pressure to remove earlier
Federal controls on state actions, such as in
legislation to repeal the McFadden Act. In
that case, Congress a half-century ago specifically delegated authority to the states to
regulate interstate commerce in a specific
industry; i.e., to allow the statesto utilize state
lines as barriers to the expansion of interstate
banking businesses. These conflicting pressures seem likely to continue, despite the
approach under the New Federalism toward
expanding the scope of state and local
control.
Remaining issues
A number of important issues still remain.
Perhaps the basic issue is simply -what is a
bank? (See the Weekly Letters of January 22
and January 29, 1982.) In the past, we could
argue that only banks through their deposittaking and lending activities created deposits.
Today, however, that distinction between
bank and nonbank firms no longer applies,
especially with the sharp increase in check'
able deposits at thrift institutions, and with
non-depository institutions (such as securities
brokers and dealers) offering money-market
mutual funds.
Another issue involves the measure of competition -i.e., the number of competitors in
the financial industry, or the scope, pricing
and convenience of the services which they
offer. Related to this is the question of when
size becomes socially undesirable, regardless
of economies of scale,and other considerations of economic efficiency. If we substitute
With the second session of the 97th Congress
now convening, the House and Senate Banking Committees will resume deliberations on
both "emergency" and comprehensive
"restructuring" legislation -just as they did
in 1 933. Thus, it may be worth noting atthis
time what the authors of the Glass-Steagall
Act had to say about this basic problem: "the
United States will never have a completely
strong banking system until such time as it
should succeed in fully harmonizing and adjusting state and federal laws on banking
matters." Forty-nine years later . . . .
the word IIsuccess"or "size," we can perf
haps understand the nature of the dilemma
more clearly.
Other questions concern the appropriate
dividing line between competition and cooperation in financial markets. For example, the
pioneering BankAmericard found its most
effective competitor in a rival vehicle developed by a group of other large banks acting
Verle B, Johnston
3
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BANKINGDATA-TWELFTH
FEDERAL
RESERVE
DISTRICT
Loans
(gross,
adjusted) investments*
and
loans(gross,
adjusted)
-total#
Commercial industrial
and
Real
estate
Loansto individuals
Securitiesloans
U.S. Treasurysecurities*
Othersecurities*
Demand
deposits total#
Demand
deposits adjusted
Savings
deposits total
Timedeposits total#
Individuals, & corp.
part.
(large negotiableCD's)
WeeklyAverages
of Daily figures
MemberBankReserve
Position
ExcessReserves )jDefidency (-)
(+
Borrowings
if
Net free reselVes )/Net borrowed(-)
(+
Amount
1/20/82
156,170
135,001
41,458
55,912
23,712
2,038
6,031
15,138
40,398
28,042
30,754
90,077
81,059
35,953
Weekended
1/20/82
83
21
62
Change
from
1/13/82
- 161
- 288
- 231
24
48
- 40
194
- 67
-1,613
-1,943
- 280
528
483
218
Changefrom
year ago
Dollar
Percent
9,222
10,556
4,498
5,221
81
564
771
542
1,556
2,129
1,477
14,457
15,095
6,334
Weekended
1/13/82
6.3
8.5
12.2
10.3
0.3
38.3
- 11.3
3.5
3.7
7.1
5.0
19.1
22.9
21.4
Comparable
period
56
131
75
-
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Wi<1!I \\{j;)) J
<Oi@
d Wi
(Dollar amounts in millions)
Outstanding
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'i\JTW2 'iill'W2
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'j!Ie'J IO)SpueJ:I UPS
ZS. 'ON lI WH1d
Selecled
Assets
andLiabilities
Large
Commercial
Banks
eUOZ!lV •
47
312
265
* Excludestrading account securities.
# Includes items not shown separately.
Editorialcomments beaddressed theeditor(WilliamBurke) to the author.... Free
may
to
or
copies this
of
andotherFederal
Reserve
publications beobtained calling writingthePublic
can
by
or
Infonnation
Section,
Federal
Reserve of San-Francisco Box7702,sanFrancisco
Bank
94120.Phone
(415)
1 P.O.
<Oi(Q]
@FedFRASER