Academic journal article The American Journal of Economics and Sociology

The Long and Bumpy Road to Glass-Steagall Reform: A Historical and Evolutionary Analysis of Banking Legislation. (Other Articles)

Academic journal article The American Journal of Economics and Sociology

The Long and Bumpy Road to Glass-Steagall Reform: A Historical and Evolutionary Analysis of Banking Legislation. (Other Articles)

Article excerpt

JILL M. HENDRICKSON (*)

ABSTRACT. This paper focuses on understanding the role of interest groups and markets in influencing regulatory change. To that end, it first identifies the interest groups surrounding the creation of legislation that separated commercial and investment banking in the 1930s and then identifies the interest groups involved in the more recent attempts to repeal the separation. Careful attention is also given to developments in the private market that affect the legislative process. This then becomes the case study for understanding how interest groups and market developments are able to influence regulatory policy. This particular case study finds that existing orthodox economic and political science literature gives too much credit to interest groups and not enough credit to private market developments when analyzing policy development and reform.

[T]he Banking Act of 1933 (passed last week by accident because a Presidential blunder kept Congress in session four days longer than expected) requires private bankers to give up either their banking or their securities business. (Time, June 26, 1933, p. 45)

I

Introduction

COMMERCIAL BANKERS PLAY A VITAL ROLE in the well-being of an economy. They function as intermediaries that bring together savers and borrowers to allow for economic expansion and the realization of entrepreneurial goals. A well-functioning banking system is, thus, a necessary condition to a well-functioning economy. During the Great Depression neither banking nor the macro-economy functioned very well. As a consequence, a comprehensive legislative package was passed to regulate and reform banking. An important part of this legislative reform was the Glass-Steagall provisions of the Banking Act of 1933. These provisions essentially separated commercial and investment banking. Investment banks were no longer able to accept deposits and commercial banks were no longer able to invest in, underwrite, or distribute corporate securities.

Sixty-six years later Congress passed a bill to dismantle Glass-Steagall. This legislative development came after years of congressional debate. While Congress was busy in debate, the courts and regulators were slowly removing barriers by allowing commercial banks into investment banking and insurance sales. At the same time, the financial market and technological developments made Glass-Steagall increasingly inappropriate if commercial banks were to remain a viable member of the financial sector. Market innovations coupled with relaxed regulation meant that by the end of the millennium the only barrier remaining between commercial and investment banks and insurance sales was Glass-Steagall.

The purpose of this paper is to determine what role interest groups and the market have played in the life of Glass-Steagall. Existing regulatory literature from economics and political science tends to emphasize interest groups and under emphasize, or even neglect, the role that markets play in the creation or reform of regulation and legislation. A careful look at both the creation and dismantling of Glass-Steagall suggests that market developments actually play an important role in the timing and nature of regulation and reform. Further, it becomes clear that regulation disrupts the market process, forever altering the regulated industry and its participants.

II

Relevant Literature

TWO CLASSIFICATIONS of existing literature may be helpful in the analysis of the role played by markets and interest groups in regulatory change. On the one hand, it is important to understand what current literature says about gaining access to changing legislation, particularly regulation. Thus, we initially review literature on the political process. However, it is equally important to understand the theory of economic regulation, which says something about how regulation is created and also changed. …

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