The Glass-Steagell Act During The Great Depression

The Great Depression of the 1930s changed the public policy perception regarding financial regulation. The regulatory framework under the Banking Act of 1933, popularly known as the Glass-Steagell Act, reformed the banking system in the United States. It was introduced to prevent the rate wars happening at exorbitant levels, as well as to curb conflicts of interest and excessive risk-taking financial activities. The first provision of the Glass-Steagell act was Regulation Q, which placed ceilings on depository interest rates. The second provision, Federal Deposit Insurance Corporation (FDIC) provided insurance against consumer deposits to prevent bank failures which were a common phenomenon during the Great Depression. The third provision,
But in the four decades following Great Depression, few changes had been made to the regulatory framework. This was not a problem till the 1970s since there was little financial innovation in this period and the interest rate ceilings established by Regulation Q were not much of a constraint considering the prevailing market conditions. Before World War II, the Fed was pegging treasury rates below the Regulation Q ceilings. The Federal Reserve Treasury Accord of 1951 freed this pegging policy resulting in a rise in market interest rates and consequently cost-push inflation. Thus banks began lobbying against the Glass-Steagell act as it was becoming redundant with the emergence of new financial instruments that were combining both the deposit and securities markets. Along with that, foreign investment opportunities were seemingly more attractive in relation to the regulated domestic financial environment. The rapid growth of the European and Japanese banks in international financial markets proved hugely detrimental to the market position of American banks and its earnings. To top that, high inflation picked up in the 1970s leading to the disintermediation crisis. Monetarists incorrectly recognised the situation as demand-pull inflation where there was excessive money in the hands of the public and thus adopted tight monetary policy. In reality though, contrary to the conventional wisdom of the time, it was cost-push inflation with rise in marginal costs during a period of economic slowdown (Canova, 1995). This automatically led to a rise in market interest rates. This rise in interest rates ended up being a continuous process due to tighter money supply, making investment a costly activity and bringing down employment and aggregate