Question

In light of the recent financial crisis of 2007-2009, do you think that the firewall created by the Glass-Steagall Act of 1933 between commercial banking and the securities industry proved to be a good thing or not?

Answer 1

In 1933 Glass Steagall Act was passed as a response to the great depression in US. The following things were included in Glass Steagall act
1. Commercial banking was separated from investment banking.
2. It established the FDIC( Federal Deposit Insurance Corporation) which provides insurance to depositors in commercial banks and other institutions.
3. It regulated speculative transactions by commercial banks.
4.It significantly stifled the commercial operations of banks

The firewall would not have been effective in preventing financial crisis of 2007-09 because of following reasons:
1. Glass Steagall act only had restriction on banks . However the financial crisis was due to speculative activities of investment banks. Most investment banks were involved in Credit Default swaps. Credit default swaps were issued by investment banks to protect buyers against defaults . Investment banks tried to pass on the risk to insurance companies through CDS but when default was huge even insurance companies could not cover the losses of investment banks. Lehmann Brother was such a case.
2. The housing loan regulation was not covered under glass steagall . Loans were provided to subprime borrowers for housing loan. This created a housing bubble as housing loans increased. Moreover down payment were required for loans . These further increased the risk . This housing bubble could not have been prevented by Glass Steagall Act.