The Glass-Steagall Act of 1933 created the Federal Deposit Insurance Corporation and instituted several economic reforms in the wake of the 1929 stock market crash and during the Great Depression. The Act separated investment and commercial banking activities, seeking to limit the conflicts of interest created when banks are permitted to underwrite stocks or bonds. At the time, improper or overzealous commercial bank involvement in stock market investment was thought to be the main cause of the financial crash.
The FDIC insured bank deposits and strengthened the Federal Reserve's control over credit.
Enactment of the Gramm-Leach-Bliley Act (GLBA) in November 1999 effectively repealed the act's prohibitions on mixing banking with securities or insurance businesses and thus permits “broad banking.”
In December 1986, the Federal Reserve Board reinterpreted Section 20 of the Glass-Steagall Act, which barred 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 permitted Bankers Trust, a commercial bank, to engage in unsecured, short-term credit transactions.
In the spring of 1987, the Federal Reserve Board eased the regulations further, despite opposition by Chairman Paul Volcker, after Citicorp, J.P. Morgan and Bankers Trust advocated loosening the restrictions to allow banks to handle several underwriting businesses, including commercial paper, municipal revenue bonds, and mortgage-backed securities.
The vice chairman of Citicorp at the time, Thomas Theobald, argued that three checks on corporate wrongdoing had developed since 1933: a very effective SEC, knowledgeable investors, and sophisticated rating agencies. Volcker, however, expressed his fear that lenders would market bad loans to the public in pursuit of lucrative securities offerings.
In March of 1987, the Fed approved Chase Manhattan's application to underwrite commercial paper, applying the same reasoning as in the 1986 Bankers Trust decision. The Fed Board said the original Congressional intent of the act allowed for some securities activities. The Fed also indicated that it would raise the limit from 5 to 10 percent of gross revenues in the future.
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.