This year marks the hundredth anniversary of the Federal Reserve Act, often described as the most important financial law in U.S. history. This year also is the 80th anniversary of the Glass-Steagall Act, which President Franklin Roosevelt called "the second most important banking legislation enacted in the history of our country."
One member of Congress, Carter Glass, was the principal author of both the Federal Reserve Act in 1913 and the Glass-Steagall Act 20 years later. This anniversary year provides the opportunity to review Glass's remarkable achievements and their relevance today.
At the start of the twentieth century the United States lacked a public authority that could respond to economic emergencies. During the Panic of 1907, rescues of commercial banks, trust companies, securities firms, the New York Stock Exchange, and New York City had to be organized by a private individual, J. P. Morgan. There was widespread recognition that the nation needed a formal body to deal with future financial panics. Republican Senator Nelson Aldrich proposed legislation that would create a powerful state bank based on the German model. The Aldrich plan was defeated by Democrats, Progressives, and many Republicans, who opposed a strong central bank controlled by Wall Street.
In 1910 the Democrats gained control of the House and appointed Carter Glass, a Congressman from Virginia, to head a subcommittee to prepare legislation. Glass drafted a bill that would create a decentralized system with twelve regional Federal Reserve Banks overseen by a Federal Reserve Board in Washington. The bill was opposed by conservative Republicans who wanted a strong central bank and by agrarians who saw Glass's bill as a disguised version of the Aldrich Plan. Glass persevered in both the House and Senate, striving to obtain agreement on reasonable legislation, while compromising as necessary. His bill, the Federal Reserve Act, was signed into law by President Woodrow Wilson on Dec. 22, 1913. Glass subsequently was honored as the "father of the Federal Reserve System" in a ceremony at the Federal Reserve Building in Washington.
In the 1920s Glass, by then a Senator, became concerned that commercial banks were fueling stock speculation by making loans to brokers. Even worse, Federal Reserve Banks were extending loans to commercial banks in their districts; these banks then re-lent the funds to brokers. Glass believed that unless the Federal Reserve Board used its general authority to curb these activities, a crash was inevitable.
Glass's warnings were largely ignored. Indeed, Glass was ridiculed. The stock market crashed in October of 1929.
In a highly unusual move, the Senate Banking Committee, controlled by Republicans, appointed a subcommittee chaired by Glass, a Democrat, to prepare legislation. The experience of the 1920s demonstrated that legislation granting only general authority to regulators was unlikely to work. "There is no lonelier man," the historian Frederick Lewis Allen observed, "than a government official who finds himself confronting…plausible arguments for…lax administration." Justice Louis D. Brandeis warned, "Remember the inevitable ineffectiveness of regulation."
So Glass drafted legislation that laid down precise statutory prohibitions (e.g., banks and companies affiliated with banks cannot underwrite securities; securities firms cannot accept deposits) and that gave clear directions to regulators (e.g. Federal Reserve Banks must keep informed of bank loans to determine whether they are being used for speculation). Glass met violent opposition from Wall Street and its allies in Congress. He received no assistance from President Herbert Hoover and little help from his successor Franklin Roosevelt.
But Glass persevered. His bill and the companion House bill sponsored by Rep. Henry Steagall of Alabama providing for federal insurance of deposits were melded into the Glass-Steagall Act, which Roosevelt signed into law on June 16, 1933. Roosevelt congratulated Glass for obtaining enactment of a law that "had more lives than a cat."
The Glass-Steagall Act and other New Deal measures worked. For decades, the nation avoided lax regulation, excessive speculation, and financial crises.
The 1980s inaugurated an era of deregulation. In 1989, Congress repealed the Glass-Steagall Act. The Securities and Exchange Commission exempted mortgage-backed pools from regulation as investment companies, repealed the uptick rule for short sales of securities, and reduced capital requirements for brokers. The Fed declined to crack down on unscrupulous subprime lending practices. Most importantly, the central bank refused to raise interest rates to dampen the housing bubble. This wave of deregulation produced a period of excessive speculation leading to the 2008 financial crisis.
Following that crisis Congress enacted the Dodd-Frank Act, which did not impose clear statutory requirements, but instead assigned more than 200 rulemaking projects to regulatory agencies.
History demonstrates that reliance on regulators will not work. Unless legislation itself imposes specific rules, including clear limits on the activities and size of financial institutions, we are bound to have lax regulation, excessive speculation, and another crisis.
We need a politician like Carter Glass, with the common sense, independence, and tenacity to devise meaningful financial legislation and get it enacted into law.
Matthew P. Fink, a former president of the Investment Company Institute, a mutual fund association, is writing a biography of Carter Glass.