The End of Glass-Steagall
The Glass-Steagall Act of 1933 separated commercial banking from investment banking for sixty-six years. Its repeal in 1999 by the Gramm-Leach-Bliley Act was one of the most consequential financial policy decisions of the late 20th century. The repeal did not happen suddenly. It was the culmination of two decades of regulatory erosion, industry lobbying, and a bipartisan intellectual shift toward financial deregulation. Whether the repeal contributed to the 2008 financial crisis remains one of the most debated questions in financial regulation. What is not debated is that it fundamentally changed the structure of the American financial system.
What Glass-Steagall Required
The Banking Act of 1933, known as Glass-Steagall after its Senate and House sponsors, imposed a clear division between two types of financial activity. Commercial banks, which accepted deposits from the public and made loans, were prohibited from underwriting or dealing in corporate securities (stocks and bonds). Investment banks, which underwrote and distributed new securities, were prohibited from accepting deposits.
The logic was rooted in the experience of the 1920s. Commercial banks had used depositors' money to finance speculative securities activities. National City Bank (now Citigroup) had packaged Latin American loans into bonds and sold them to retail customers, many of whom lost their entire investment when the bonds defaulted. Chase National Bank's chairman had shorted his own bank's stock during the crash. The conflicts of interest between deposit-taking and securities dealing were judged to be inherently dangerous.
Glass-Steagall forced existing institutions to choose. J.P. Morgan and Company chose commercial banking. Several partners left to form Morgan Stanley as a securities firm. The First National Bank of Boston (now Bank of America) chose commercial banking. Goldman Sachs, Lehman Brothers, and Bear Stearns remained on the investment banking side. For the next six decades, these two industries operated under separate regulatory regimes with different rules, different cultures, and different risk profiles.
The Erosion Begins
The walls between commercial and investment banking began to crack in the 1980s. Several forces drove the erosion.
Banks argued that Glass-Steagall put them at a competitive disadvantage against foreign banks, which operated without such restrictions. Deutsche Bank, Credit Suisse, and other European universal banks could offer clients the full range of financial services. American banks could not. As financial markets became more global, this competitive gap widened.
Technology and financial innovation blurred the boundaries between banking and securities activities. Money market funds, created in the 1970s, offered bank-like services (check-writing, daily liquidity) while investing in securities. Commercial paper, a short-term debt instrument issued by corporations, replaced some of the lending that banks had traditionally provided. Securitization, the process of packaging loans into tradable securities, meant that activities that looked like lending (originating mortgages) produced outputs that looked like securities (mortgage-backed bonds).
The Federal Reserve, under a provision of Glass-Steagall known as Section 20, began granting commercial banks limited permission to engage in securities activities through subsidiaries. In 1987, the Fed allowed bank holding companies to establish "Section 20 subsidiaries" that could earn up to 5% of their revenue from otherwise impermissible securities activities. This ceiling was raised to 10% in 1989 and to 25% in 1996. Each increase represented a de facto weakening of the Glass-Steagall barrier.
The Office of the Comptroller of the Currency (OCC), the regulator of nationally chartered banks, also expanded banks' securities powers through administrative rulings. Courts generally upheld these expansions, interpreting Glass-Steagall's restrictions more narrowly than the original legislative intent might have suggested.
The Citicorp-Travelers Merger
The event that made Glass-Steagall's formal repeal inevitable was the announcement in April 1998 of the merger between Citicorp, one of the largest commercial banks in the world, and Travelers Group, a financial conglomerate that owned Salomon Smith Barney (an investment bank), Smith Barney (a retail brokerage), Travelers Insurance, and Primerica (a consumer financial services company).
The merger was technically illegal under Glass-Steagall. A commercial bank could not own an investment bank and an insurance company. But the two companies proceeded with the merger on the assumption that the law would be changed before they were required to divest the prohibited activities. Federal law gave them a two-year window (extendable to five years) to come into compliance.
The merger was valued at approximately $70 billion and created the world's largest financial services company. Sandy Weill, the chairman of Travelers, and John Reed, the chairman of Citicorp, became co-CEOs of the combined entity, Citigroup. The announcement was interpreted on Wall Street and in Washington as a signal that Glass-Steagall was finished.
The Gramm-Leach-Bliley Act
The Gramm-Leach-Bliley Financial Services Modernization Act was signed into law by President Bill Clinton on November 12, 1999. It formally repealed the Glass-Steagall provisions separating commercial and investment banking and allowed the creation of "financial holding companies" that could engage in banking, securities, and insurance activities under one corporate umbrella.
The Act was the product of more than a decade of legislative attempts. Bills to repeal Glass-Steagall had been introduced in Congress since the late 1980s but had failed due to disagreements over community reinvestment requirements, insurance regulation, and the appropriate regulatory structure for combined financial firms.
The final passage was bipartisan. The bill passed the Senate 90-8 and the House 362-57. Its Republican sponsors were Senator Phil Gramm of Texas, Representative Jim Leach of Iowa, and Representative Thomas Bliley of Virginia. The Clinton administration supported the legislation. Treasury Secretary Robert Rubin, who would join Citigroup's board shortly after leaving government, was a proponent.
The signing ceremony was notable for its optimism. President Clinton said the legislation demonstrated "the power of the marketplace." Senator Gramm called Glass-Steagall "a relic of a bygone era." The prevailing view in both parties was that the Depression-era restrictions were outdated, that financial institutions could manage their risks effectively, and that allowing banks to diversify their activities would make them more stable, not less.
The Arguments For Repeal
The case for repealing Glass-Steagall rested on several arguments that had broad support among economists, regulators, and financial industry participants.
Diversification. Advocates argued that allowing banks to engage in securities and insurance activities would reduce risk through diversification. If lending losses hit the commercial bank, securities revenues could offset them, and vice versa. This argument drew on modern portfolio theory, which held that combining imperfectly correlated activities reduced overall risk.
Competitiveness. American banks were losing market share to European and Japanese universal banks that operated without Glass-Steagall-type restrictions. Repeal would allow American banks to compete on equal terms in the global marketplace.
Efficiency. Combining banking, securities, and insurance under one roof would create economies of scale and scope, reducing costs for consumers. A customer could obtain a mortgage, buy mutual funds, and purchase insurance from the same institution.
Reality. The practical barriers between commercial and investment banking had already been largely dismantled through regulatory interpretations, Section 20 subsidiaries, and financial innovation. Glass-Steagall, by this argument, was a dead letter that should be formally interred.
The Arguments Against
Opponents of repeal, though fewer in number, raised warnings that would prove prescient.
Senator Byron Dorgan of North Dakota, one of eight senators who voted against the bill, said on the Senate floor in 1999: "I think we will look back in 10 years' time and say we should not have done this." He was almost exactly right on the timing.
The core concern was that combining deposit-taking with securities activities would recreate the conflicts of interest and risk concentrations that Glass-Steagall had been designed to prevent. Banks would be tempted to use the implicit government guarantee on deposits (through FDIC insurance) to take risks in securities markets. If those risks produced losses, taxpayers would be on the hook.
Consumer advocates worried that financial supermarkets would use their market power to push unnecessary products on captive customers. Privacy concerns were also raised, as combined financial firms would have access to customers' banking, investment, and insurance data.
Some economists argued that the diversification benefits of combining banking and securities were overstated. In a crisis, all financial activities tend to lose money simultaneously, meaning that diversification fails precisely when it is needed most.
After Repeal
The years following repeal saw rapid consolidation in the financial industry. Banks acquired securities firms and insurance companies. JPMorgan Chase acquired Bank One (and later Bear Stearns and Washington Mutual). Bank of America acquired Merrill Lynch. Citigroup expanded its investment banking, trading, and insurance operations.
The financial firms that emerged from this consolidation were much larger, more complex, and more interconnected than the pre-repeal institutions. Several of them became "too big to fail," meaning that their collapse would threaten the broader financial system and might require government rescue.
The 2008 financial crisis tested the post-repeal financial structure to its breaking point. Bear Stearns collapsed in March 2008 and was absorbed by JPMorgan Chase with Federal Reserve assistance. Lehman Brothers filed for bankruptcy in September 2008. Merrill Lynch was sold to Bank of America in a hastily arranged deal. AIG, which had sold credit insurance (credit default swaps) on mortgage-backed securities, required a $182 billion government bailout. Citigroup, the poster child of Glass-Steagall repeal, received $45 billion in TARP funds and $301 billion in government guarantees on toxic assets.
The Debate Over Culpability
Whether Glass-Steagall's repeal contributed to the 2008 crisis is one of the most debated questions in financial regulation.
Those who blame the repeal argue that it allowed banks to combine deposit-taking with high-risk securities trading, creating institutions that were too large, too complex, and too interconnected to manage safely. They point to Citigroup's massive losses on mortgage-backed securities as evidence that combining commercial and investment banking was inherently dangerous.
Those who defend the repeal point out that the institutions at the center of the crisis, Lehman Brothers, Bear Stearns, AIG, Fannie Mae, and Freddie Mac, were not commercial banks. Lehman and Bear Stearns were pure investment banks that would not have been affected by Glass-Steagall. AIG was an insurance company. The mortgage origination that fueled the crisis occurred at both commercial banks and non-bank lenders. The crisis, by this argument, was caused by inadequate risk management, poor regulation of mortgage lending, and excessive reliance on complex securitized products, not by the combination of commercial and investment banking.
The reality is likely more nuanced. Glass-Steagall's repeal was one factor among many that contributed to the fragility of the financial system in 2008. The creation of large, complex financial conglomerates made the system more difficult to supervise and more prone to contagion. The implicit government guarantee on deposits may have encouraged risk-taking in securities activities. But the specific toxic instruments that caused the crisis, subprime mortgage-backed securities and credit default swaps, could have been and were created without the combination of commercial and investment banking.
The Aftermath
The Dodd-Frank Act of 2010 did not restore Glass-Steagall. It imposed the Volcker Rule, which prohibited banks from proprietary trading (trading for their own account rather than on behalf of clients), a partial separation of banking and trading. But the combined financial holding company model was not dismantled.
Calls to restore Glass-Steagall have persisted. Senators Elizabeth Warren and John McCain introduced the "21st Century Glass-Steagall Act" in 2013. Similar proposals have been introduced in subsequent congressional sessions. None have been enacted.
The financial industry continues to operate under the combined model that Gramm-Leach-Bliley enabled. JPMorgan Chase, Bank of America, Citigroup, Goldman Sachs, and Morgan Stanley all operate as financial holding companies that combine commercial banking, investment banking, trading, and asset management. The question of whether this structure is stable and appropriate remains open, waiting for the next crisis to provide evidence.
The Lesson of Glass-Steagall
The story of Glass-Steagall, from its creation in the crisis of 1933 to its erosion in the 1980s to its repeal in the optimism of 1999 to the crisis of 2008, follows a pattern that recurs throughout financial history. Regulations are created in response to crises. They work well for a time. The memory of the crisis fades. The regulated industries argue that the restrictions are outdated and costly. The restrictions are loosened or removed. Eventually, a new crisis occurs, and the cycle begins again. Whether the specific regulation in question is Glass-Steagall or something else, the pattern of crisis, regulation, complacency, deregulation, and crisis has been remarkably consistent across two centuries of financial history.
Put these principles into practice. Track fundamentals, build portfolios, and analyze stocks with AI-powered insights.
Start Free on GridOasis →