An increasingly common topic reared its head during a recent Federal Reserve press conference.

While Fielding questions following the March 15 announcement of an interest rate hike, Fed Chair Janet Yellen was asked to weigh on the Glass-Steagall Act, a banking regulation guttedmany years ago. Before coming off the books during the Clinton Administration, it imposed a separation between commercial and major investment banks

The question, from John Heltman, a reporter for American Banker: “Is the fundamental idea of separating commercial banking from investment banking a fruitful line of inquiry?”

“I have not seen any concrete proposals along this line,” Yellen answered. “I don’t really know what a 21st-century Glass-Steagall would look like.”

“An important reform in the aftermath of the Financial Crisis was to make sure that investment banking activities … had appropriate liquidity and their management was strengthened,” Yellen added. “That’s what we have tried to do … I do feel that we have significantly strengthened supervision of bank holding companies that incorporate investment banking activities.”

That Yellen was asked to opine on a long-dead regulation is the latest twist in a storyline that has both Republicans and Democrats jockeying to bring back the law.

The Glass-Steagall Act was passed by Congress in 1933, in the wake of the Great Depression. Similar to more modern “ring fencing,” it prohibited commercial banks from engaging in investment business. The law was revoked in 1999, during a pro-business deregulation push by the Clinton Administration. The Dodd-Frank Act’s Volcker rule, a prohibition on proprietary trading by federally insured depository institutions, was an effort to fill the longstanding regulatory gap.

Reinstating the law was included in pre-election party platforms by both Democrats and Republicans. It is also an idea that seems to be gaining traction in the Trump Administration.

Press Secretary Sean Spicer was asked about bringing it back during a March 9 press conference, placed into the context of the regulatory burden faced by community banks. Since 2008, the number of small banks has declined 30 percent, he said.  


“Dodd-Frank alone has resulted in 22,000 pages of new regulations,” Spicer said. “While large banks can hire armies of compliance officers whose sole purpose it is to ensure they meet the ever-growing number of regulations, it increases the cost of doing business for community banks, leading some not to engage in some forms of lending, or simply due to the time and costs involved.”

Spicer was asked whether easing this regulatory burden might include streamlining current rules in favor of a new Glass-Steagall Act. Spicer’s short, telling answer: “Yes.”

Likewise, Sen. Bernie Sanders, a Vermont Democrat and former presidential candidate, has offered to work with President Donald J. Trump on crafting and passing a modernized version of the one-time law.

During his confirmation process, Treasury Secretary StevenMnuchin gave similar support to a “21st Century Glass-SteagallAct.”

“I don’t support going back to Glass-Steagall as is,” he said. “What we’ve talked about with the President is perhaps the need for a 21st-century Glass-Steagall.”

Calls to reinstate the law are nothing new. In 2013, senators Warren (D-Mass.), Cantwell (D-Wash.), McCain (R-Ariz.), and King (I-Maine) offered a new plan for separating traditional banks (with savings and checking accounts that are insured by the FDIC) from riskier financial institutions that provide investment banking services, insurance, swaps dealing, and hedge fund and private equity activities.

Improving the old law, they said, would keep banks from simply adding a technical partition between commercial and investment banking operations.

What, exactly, would a modern Glass-Steagall Act look like? Thomas Hoenig, vice chairman of the Federal Deposit Insurance Corporation, has a very detailed plan for rethinking bank regulation.

During a March 13 speech before the Institute of International Bankers in Washington D.C. he laid out a proposal for accomplishing much of what both critics of over-regulation and Glass-Steagall proponents are hoping for.

The United States has experienced 14 major banking crises dating back to 1837. Rather than try to prevent bank failures, thegoal should be “to prevent the consequences of failures from requiring public bailouts and instead allow private owner equity to absorb the shocks,” Hoenig said.

Developing the core principle of the one-time Glass-Steagall Act, his proposal would place “non-traditional bank activities into separately managed and capitalized affiliates.”

Traditional banking activities generally found in an insured depository institution and nontraditional banking activities, such as investment banking, would each be structured under one or more separately capitalized intermediate holding companies of a financial holding company (FHC). 

Each intermediate holding company that houses nontraditional banking activities would be a separate affiliate, separately capitalized and managed from the insured bank. Each intermediate holding company would be structured in a manner that makes it a "resolvable" entity able to withstand the normal bankruptcy process.

A non-traditional intermediate holding company would be capitalized using tracking shares issued by the ultimate parent. Tracking shares are generally a separate class of stock of the holding company that give economic rights to a discrete set of assets—in this case the shares of the intermediate holding company. This would allow management to unlock value in each line of business while insulating the insured depository institution from potential losses.

The non-traditional intermediate holding company would also be subject to independent liquidity requirements designed to eliminate or limit access to the public safety net and to ensure that, if it were to be fully separated from the financial holding company, it could continue to operate and function on its own in the market and be resolvable through normal bankruptcy. 

The ultimate parent company and its affiliates would be constrained in the amount of debt funding they provide to the nontraditional intermediate holding company. 

“As with any prudentially regulated entity, the ultimate responsibility for safety and soundness rests with the board of directors and senior management,” Hoenig said. Internal oversight would be reformed so there is a separation of management across the affiliated entities.


The following is a selection from FDIC Vice Chairman Thomas Hoenig’s presentation to the Institute of International Bankers on March 13.
Promoting economic strength and sustainable growth is a common objective of nations around the world, and the shape of the financial landscape in which this can best be achieved is rightly subject to fierce debate. As we contemplate the paradigm here in the United States, we have two distinct choices. One is to preserve the system that emerged from the most recent financial crisis. The other is to reshape and reinvigorate the banking system by ending too-big-to-fail, enhancing competition, and rebuilding trust in our financial firms.
As memory of the financial crisis of 2008 fades, we must remain vigilant. We all know that this event was not the only one of its kind. Indeed, the United States has experienced 14 major banking crises dating back to 1837. I have been on the front line for at least three of them in the 40-plus years that I have worked in bank supervision. While the reasons behind each crisis have been different, each has caused serious harm to individuals and the economy. It does not matter what politician or party is in office or whether new technology is put in place to better inform the industry, banks will inevitably come under stress and some will fail—and a truly capitalistic system should allow them to do so.
Rather than try to prevent bank failures, our goal should be to prevent the consequences of failures from requiring public bailouts and instead allow private owner equity to absorb the shocks.
The Dodd-Frank Wall Street Reform and Consumer Protection Act was enacted in response to the most recent crisis. While well intended, its many and complicated regulations are burdensome for all banks, but especially smaller banks. The legislation also has served to enshrine too-big-to-fail for the largest, most complex universal banks, providing them with a powerful competitive advantage.
Today I will outline an alternative approach to better address the challenge of too-big-to-fail, regulatory burden, and competitive equity. The proposal would not reduce the ability of a universal bank to conduct any of its current portfolio of activities, whatever they might be. It would, however, partition nontraditional bank activities into separately managed and capitalized affiliates to return the safety net back to its original scope and purpose.
The proposal also would require greater owner equity at risk for large, complex, universal banks, as defined in the accompanying term sheet. With these conditions in place, too-big-to-fail would be well on its way to being addressed, and a true opportunity for regulatory relief for these largest banks would be provided. We could pare back the thousands of pages of rules that inhibit bank performance and level the competitive playing field without undermining the stability of our financial system and economy.
Source: FDIC

Each intermediate holding company would have its own board of directors, under the plan. Each financial holding company would be required to have an independent general internal auditor responsible for the audit function of the company in its entirety and who reports directly to the board of directors.

Management would no longer be allowed to serve on the boards of directors.

A centerpiece of the proposed banking reforms is sustaining investment banking for the long term.

“Investment banking is an essential element of the economic success of the United States, and its intent is to buttress this success,” Hoenig said. “Through the booming 20th century and during the era of Glass-Steagall, investment banks underwrote companies that helped to build the modern economy and became part of the national fabric.”

Under the plan, “banks would get relief from the Volcker Rule,” he added. “It would not be eliminated, but the burdens of it would be dramatically reduced.”

Speculative proprietary trading would still be prohibited, but through the use of trader mandates rather than through the complexities of the current rule. An insured bank would be prohibited from owning or sponsoring a private equity or hedge fund, but the separately managed and capitalized affiliates would be able to do so with proper controls in place and assurances that the safety net was appropriately confined and risk adequately capitalized.

Around Washington, Hoenig’s proposal, which would require Congressional action, is gaining traction and garnering excitement. Fueling it is buzz that the FDIC official is in line for a top post within the Trump Administration. Specifically, he could become the Federal Reserve’s vice chairman for supervision, a top regulatory post that was created by the Dodd-Frank Act, but never filled.

Dennis Kelleher, president and CEO of the investor advocacy group Better Markets, calls Hoenig’s proposal “serious, comprehensive, fact-based, and deeply thoughtful.  

“The core tradeoff is a substantial increase in bank capital in exchange for a lowering of regulatory requirements,” he says. “Because the capital equity cushion is all that stands between a systemically significant bank and taxpayers’ pockets, the key to this proposal is how much capital and the details of the resulting reduced regulatory requirements.”

Nevertheless, while the plan may be a step in the right direction, Kelleher thinks a 10 percent capital leverage ratio “is simply too low to reduce the risk of a fragile financial system and yet more financial crashes, taxpayer bailouts, and economic catastrophe.”

The biggest, most dangerous megabanks incurred losses and recapitalization needs of roughly 20 percent of risk-weighted assets during the 2007–2009 financial crisis, according to the Fed and other global regulators. “Those losses were only as ‘low’ as 20 percent because the U.S. government and taxpayers bailed out the entire global financial system, thereby putting a floor under the megabanks’ losses,” he said.

That concern aside, the “proposal deserves the widest consideration by all those in public office with the public duty to protect America’s families from another financial and economic catastrophe,” Kelleher said

Meanwhile, in Congress, Rep. Marcy Kaptur (D-Ohio) hasannounced new legislation, the “Return to Prudent Banking Act,” calling for the re-enactment of the Glass-Steagall Act.

“The 2008 crash nearly took down our entire economy and led to the great recession which wiped out average Americans’ income. But now, Democrats and Republicans have memorialized support for Glass-Steagall in their respective political platforms. Even President Trump has declared his support for a new Glass-Steagall law,” she said in a statement.