Taming the Megabanks

This book demonstrates that universal banks—which accept deposits, make loans, and engage in securities activities—played central roles in precipitating the Great Depression of the early 1930s and the Great Recession of 2007–09. Universal banks promoted a dangerous credit boom and a hazardous stock market bubble in the U.S. during the 1920s, which led to the Great Depression. Congress responded by passing the Glass-Steagall Act of 1933, which separated banks from the securities markets and prohibited nonbanks from accepting deposits. Glass-Steagall’s structural separation of the banking, securities, and insurance sectors prevented financial panics from spreading across the U.S. financial system for more than four decades. Despite Glass-Steagall’s success, large U.S. banks pursued a twenty-year campaign to remove the statute’s prudential buffers. Regulators opened loopholes in Glass-Steagall during the 1980s and 1990s, and Congress repealed Glass-Steagall in 1999. The United Kingdom and the European Union adopted similar deregulatory measures, thereby allowing universal banks to dominate financial markets on both sides of the Atlantic. In addition, large U.S. securities firms became “shadow banks” as regulators allowed them to issue short-term deposit substitutes to finance long-term loans and investments. Universal banks and shadow banks fueled a toxic subprime credit boom in the U.S., U.K., and Europe during the 2000s, which led to the Great Recession. Limited reforms after the Great Recession have not broken up universal banks and shadow banks, thereby leaving in place a financial system that is prone to excessive risk-taking and vulnerable to contagious panics. A new Glass-Steagall Act is urgently needed to restore a financial system that is less risky, more stable and resilient, and better able to serve the needs of our economy and society.

Reckoning

In March 1933, President Franklin Roosevelt declared a national bank holiday and persuaded Congress to approve emergency measures to revive the U.S. banking system. Those measures included capital infusions from the Reconstruction Finance Corporation and asset-backed loans from the Federal Reserve. National City Bank, Chase National Bank, and other universal banks received large bailouts, which enabled them to withstand the huge losses they suffered from their securities operations and related loans. Roosevelt also supported legislation proposed by Senator Carter Glass and Representative Henry Steagall to prohibit banks from engaging in securities activities and to bar nonbanks from accepting deposits. A Senate investigation led by Ferdinand Pecora revealed widespread abuses in securities offerings made by National City, Chase, and other universal banks and private investment banks during the 1920s. Pecora’s revelations generated widespread public support for the Glass-Steagall Act, which Roosevelt signed into law in June 1933.

15. Banks and the Capital Markets

This chapter considers banks' securities activities. Many banks have compensated for the decline in traditional finance by emphasizing their securities activities. These range from the traditional task of investment banks in advising, underwriting, and distributing new issues of securities, through to dealing on their own account on securities and derivatives markets — proprietary trading. In the decade leading up to the Global Financial Crisis, banks also played a significant role in introducing new products to these markets, including asset-backed securities and credit derivatives. The onset of the crisis provoked intense scrutiny and widespread criticism of many of these activities, and led to the introduction of significant controls on the ability of banks to engage in them. The chapter discusses types of securities, subordination, and custody; distributing securities issues; and securities regulation.