Library of Congress

Bureau of Labor Statistics

By Arthur E . Wilmarth , Jr .

Banks became major players in US securities markets twice in the past century — first during the 1920s and again after the mid-1990s . Both times , “ universal banks ” ( banks involved in securities activities ) helped to promote unsustainable credit booms that led to devastating busts — the Great Depression of the early 1930s and the Great Recession of 2007-09 . Both times , governments arranged costly bailouts to rescue universal banks .

During the booms that preceded the Great Depression and Great Recession , universal banks sold risky securities as “ safe ” investments to purchasers around the world . Universal banks supported their securities operations with speculative loans , investments and guarantees . During both periods , conflicts of interest within universal banks destroyed their ability to act as objective lenders or as impartial investment advisers .

Congress passed the Glass-Steagall Act of 1933 to separate banks from the securities markets . The Glass-Steagall Act established a decentralized financial system consisting of three independent sectors : banking , securities and insurance . That system was stable and successful for more than four decades .

Regulators opened loopholes in the Glass-Steagall Act during the 1980s and 1990s , and Congress repealed the Act ’ s core provisions in 1999 . The reintroduction

Iconic images from the Great Depression and Great Recession . Left : Crowds gather outside the New York Stock Exchange during the Crash of 1929 . Right : Foreclosures soared in 2007 , causing the subprime mortgage market to crash . of universal banks helped to produce the toxic subprime lending boom of the 2000s , which led to the Great Recession . Unlike the Great Depression , the Great Recession did not cause the United States and most other developed nations to separate banks from the capital markets .

In 2010 , Congress passed the Dodd- Frank Wall Street Reform and Consumer Protection Act ( Dodd-Frank ). Dodd- Frank mandated a series of technical regulatory reforms that tried to make universal banks safer . Other developed nations approved similar measures . Despite those reforms , governments found it necessary to prop up universal banks again during the worldwide financial crisis triggered by the COVID-19 pandemic in 2020 .

As shown by the pandemic crisis , Dodd-Frank ’ s reforms failed to address the root causes of the global financial crisis of 2007 – 09 . Our financial system remains dangerously unstable , due to excessive risks created by universal banks and “ shadow banks ,” such as private equity firms , hedge funds and large asset managers . We urgently need a new Glass-Steagall Act to restore financial stability and ensure that our financial system serves the interests of consumers and Main Street businesses , rather than Wall Street speculators .

First-Generation Universal Banks , the Great Depression and the Glass-Steagall Act

Large US commercial banks took advantage of loopholes in federal and state laws to create embryonic universal banks in the early 1900s . Those banks sold large volumes of war bonds during World War I , and they greatly expanded their securities activities after the war . During the 1920s , American universal banks aggressively competed with private investment banks to underwrite and distribute risky domestic and foreign bonds and speculative stocks to investors around the globe . The heated rivalry between universal banks and investment banks produced an enormous credit boom , which fueled dangerous bubbles in securities and real estate markets on both sides of the Atlantic .

Market values of securities and real estate investments collapsed in the United States after the Great Crash of October 1929 , inflicting grievous losses on investors , borrowers and creditors , including universal banks and investment banks . Those losses triggered widespread loan defaults , as well as steep declines in household consumption and business activity . The resulting downturn in the US economy destroyed tens of thousands of businesses and millions of jobs , paving the way for the Great Depression .

The disasters experienced in the United States spread to Europe and Latin America , where many governments and businesses relied on loans from American bankers during the 1920s . The sudden shutdown of the foreign bond market in the early 1930s and the resulting disruption of international credit flows precipitated severe financial and economic crises in Austria , Germany , Italy , Belgium and other European nations .

32 FINANCIAL HISTORY | Fall 2022 | www . MoAF . org