Legal Definitions - Glass–Steagall Act

The Glass-Steagall Act, officially known as the Banking Act of 1933, was a landmark United States federal law designed to protect the stability of the banking system and safeguard the funds of ordinary depositors. Its primary purpose was to create a strict separation between traditional commercial banking activities—such as accepting deposits and making loans—and the more speculative activities of investment banking, which involve dealing in securities like stocks and bonds. The Act specifically prohibited commercial banks from owning or operating brokerage firms, underwriting securities, or engaging in other investment banking businesses. The intention was to prevent banks from taking on excessive risks with depositors' money by speculating in the stock market, a practice believed to have contributed to the financial instability of the Great Depression era.

• Example 1: Imagine a large commercial bank, "Secure Deposits Bank," in the 1950s. Its executives identify a growing interest among their customers for stock market investments. They propose creating a new division within the bank that would actively buy and sell stocks and bonds on behalf of clients, essentially operating as an in-house brokerage service. Under the Glass-Steagall Act, this proposal would be legally impossible. Secure Deposits Bank would be prohibited from directly engaging in the brokerage business or underwriting securities, as the Act mandated a clear separation between its deposit-taking functions and the inherent risks of the securities market.

• Example 2: Consider "Community Trust Bank," a traditional bank focused on providing mortgages and small business loans in the 1970s. The bank's board sees an opportunity to expand its revenue by acquiring "MarketWise Investments," a successful local firm specializing in advising clients on stock portfolios and managing investment funds. If the Glass-Steagall Act were still fully in effect, Community Trust Bank would be legally barred from acquiring MarketWise Investments. The Act prevented commercial banks from owning or being affiliated with firms that primarily engaged in the securities business, ensuring that the bank's core operations remained distinct from investment activities.

• Example 3: During the era when the Glass-Steagall Act was in full force, a commercial bank like "Main Street Savings" would have been unable to use its depositors' funds to underwrite a new issue of corporate bonds for a rapidly expanding technology startup. This means Main Street Savings could not have acted as an intermediary, purchasing the bonds directly from the company and then reselling them to investors. The Act ensured that Main Street Savings focused solely on its core banking functions, like providing mortgages and business loans, thereby insulating its depositors from the potential losses associated with the volatile securities market and preventing the bank from taking on the risks of a securities dealer.