The Candidates Just Discussed Glass-Steagall. Here's What You Should Know About It

November 15th 2015

Mike Vainisi

At the Democratic debate on Saturday night, the three candidates—former Sec. Hillary Clinton, Sen. Bernie Sanders, and former Gov. Martin O'Malley—had a contentious debate on the topic of Glass-Steagall.

Related: Here's What a Nobel Prize-Winning Economist Has to Say About the Student Debt Crisis

So what's Glass-Steagall?

It used to be a law in the United States. It was passed in 1933 after the stock market crash that led to the Great Depression, and it applied to banks. The idea was that one bank should not be able to simultaneously practice both commercial banking and investment banking. What's the difference? Commercial banking is basically what normal consumers do every day—using a debit card, opening a savings account, or getting a loan for house or small business. Investment banking refers to what we see in corporate America or on Wall Street. It's when a bank helps facilitate a big business deal—one company buying another, for example.

Investment banking is inherently riskier than commercial banking. During the Great Depression, many believed that failures in investment banking spread to commercial banking and therefore hurt regular people when banks collapsed and took their customers' savings with them.

So, Glass-Steagall said that one financial institution could not do both.

Why did we get rid of Glass-Steagall?

As time went on, banks started to argue that the regulation was too strict and didn't really protect regular people from risky behavior on Wall Street. They also argued that the rule put them at a disadvantage against European competitors who were not under this restriction. In 1999, it was effectively eliminated with the Gramm-Leach-Bliley Act, which was passed by Congress and signed by President Bill Clinton.

Did the repeal of Glass-Steagall cause the financial crisis of 2008?

It depends on who you ask.

Some, such as Sen. Elizabeth Warren (D-Mass.), argue that the overturning of Glass-Steagall led to the 2008 financial crisis and the ensuing Great Recession. Joseph Stiglitz, a Nobel-prize winning economist, made this argument in Vanity Fair in 2009 in the midst of the crisis:

"The most important consequence of the repeal of Glass-Steagall was indirect—it lay in the way repeal changed an entire culture. Commercial banks are not supposed to be high-risk ventures; they are supposed to manage other people’s money very conservatively. It is with this understanding that the government agrees to pick up the tab should they fail. Investment banks, on the other hand, have traditionally managed rich people’s money—people who can take bigger risks in order to get bigger returns. When repeal of Glass-Steagall brought investment and commercial banks together, the investment-bank culture came out on top."

On the other hand, as PolitiFact points out, "[i]t’s safe to say...that there is not a prominent group of economists who argue 'but for the 1999 repeal of Glass-Steagall, the crisis would not have happened.'" Politifact also cited Lawrence White, an economist at NYU, who says that Glass-Steagall would not have prevented the risky activity on Wall Street that led to the crisis. Additionally, "[o]f the big firms that got into trouble and helped trigger the crisis, only a few were the mega-banks enabled by the action on Glass-Steagall," the Upshot's Neil Irwin wrote last month.

There's no way to say for sure whether repealing Glass-Steagall caused the 2008 recession. While most would say this is far too simple of an explanation for something as complicated as a financial crisis, it is fair to say that Glass-Steagall's demise helped the banks get much bigger.

So where do the Democratic candidates stand on Glass-Steagall?

Sanders and O'Malley are in favor of reinstating the rule, saying that it will reduce the power of banks.

Clinton is not in favor of bringing the law back, arguing that the law would not do enough to prevent a future crisis.