Glass-Steagall Repeal and the 2008 Financial Crisis
This paper examines the role of financial deregulation in causing the 2008 financial crisis, focusing on the Glass-Steagall Act of 1933 and its repeal through the Financial Services Modernization Act of 1999. The paper traces how Glass-Steagall's separation of commercial and investment banking had long prevented excessive speculation, and how eliminating that barrier encouraged overleveraging, the creation of complex securities, and the formation of dense risk-sharing networks among banks. It also considers how the crisis spread internationally, affecting countries whose banks held exposure to American toxic assets or pursued similar deregulatory strategies.
- Introduction: The Purpose of Glass-Steagall: Origins and rationale of the 1933 Glass-Steagall Act
- The 1999 Repeal and Market Reactions: FSMA passage and initial market responses
- Increased Risk-Taking and Systemic Leverage: How deregulation drove bank overleveraging
- Interconnected Risk and the Global Crisis: Risk networks and international financial contagion
- Conclusion: Deregulation's role in worsening the crisis
✍️ How to write this paper — guide, tools & examples ▾
What makes this paper effective
- The paper builds a clear causal chain from Glass-Steagall's original purpose through its repeal to the resulting financial crisis, making the argument easy to follow.
- It uses specific legislation and named economic events as anchors, grounding the argument in verifiable historical fact rather than abstract assertion.
- The international dimension (Iceland, UK, Ireland) is briefly but effectively used to show that the systemic failure extended beyond U.S. borders, strengthening the broader claim.
Key academic technique demonstrated
The paper demonstrates effective use of legislative history as analytical evidence. By comparing the regulatory framework before and after the FSMA, the author creates a natural before/after structure that isolates deregulation as the key explanatory variable for the crisis. Supporting this with market-reaction studies (Carow, 2002; Hendersholt et al., 2002) shows awareness of empirical literature alongside policy argument.
Structure breakdown
The paper opens with the historical rationale for Glass-Steagall, then explains what changed in 1999 and how markets responded, then analyzes the behavioral consequences (overleveraging and complex securities), and concludes by describing how interconnected risk networks amplified the eventual crash. Each paragraph advances the argument one step forward, resulting in a tight, linear structure well suited to a short analytical essay.
Introduction: The Purpose of Glass-Steagall
The Glass-Steagall Act of 1933 was the first major attempt at regulating the financial industry. The Act was passed by President Roosevelt with the objective of restoring public confidence in the banking system. Glass-Steagall sought to, among other things, "prevent the undue diversion of funds into speculative operations," in response to the market crashes that had sparked the Great Depression (Maues, 2013). The reason for this was straightforward: speculation was always a temptation for the banking industry, and if left unchecked, the industry was likely to indulge in more speculation than it could sustain while maintaining financial health and public confidence.
It has been argued that Glass-Steagall, for decades, successfully prevented the kind of accumulation of speculative assets within the banking system that occurred in the 2000s. Commercial and investment banking had been separated throughout this period, which meant that if investment banks chose to engage in speculation, their failure would not affect the commercial banking system. In 1999, this separation was ended by legislation that effectively set the tone for the Great Recession a few years later.
The 1999 Repeal and Market Reactions
The changes in 1999 came about through the Financial Services Modernization Act (FSMA), which sought to remove many of the restrictions that Glass-Steagall had placed on the banking industry. The basic principle was that commercial banks were now able to take on investments and risks that they previously could not. The normal relationship between risk and return works two ways: while greater risk can yield a better return, risk is also simply volatility. The reality was that these banks were unprepared for the volatility associated with their new positions — that is to say, they had very quickly become overleveraged (Rickards, 2012).
The initial reactions to the FSMA were positive within the industry. Measurable effects included an increase in stock prices for investment banks and predictions of potential gains from economies of scope, market power, and the implicit extension of government guarantees — the so-called "too big to fail" dynamic — to banking affiliates (Carow, 2002). It was somewhat surprising that commercial banks did not respond strongly to the new laws, whereas investment banks and insurance companies did. The market expected, perhaps, the eventual acquisition of these companies by the major commercial banks. In the years after 1999, however, the larger institutions across all categories earned abnormal returns (Hendersholt, Lee, & Thompkins, 2002).
Increased Risk-Taking and Systemic Leverage
This deregulation encouraged greater risk-taking behavior among banks, including commercial banks. Investment banks, unfettered by regulation, created new securities that they could sell to commercial banks, and the banking system as a whole increased its leverage in the search for yield. This trend was echoed in many other countries as well — Iceland, the United Kingdom, and Ireland most famously. These nations allowed their banks to increase risk partly to remain competitive with the American banking industry and partly because they were following the same path of escalating risk exposure.
Conclusion
The FSMA encouraged greater risk-taking and fostered closer, more opaque links between banks — both of which made the resulting crisis far worse than it would have been had Glass-Steagall remained in place. The separation of commercial and investment banking had served as a firewall against systemic collapse; removing it eliminated that protection and left the entire financial system exposed to the consequences of speculative excess.
References
Carow, K. (2002). Capital market reactions to the passage of the Financial Services Modernization Act of 1999. Indiana University.
Grant, J. (2009–2010). What the financial services industry puts together let no person put asunder: How the Gramm-Leach-Bliley Act contributed to the 2008–2009 American capital markets crisis. Albany Law Review, 73, 371.
Hendersholt, R., Lee, J., & Thompkins, J. (2002). Winners and losers as financial service providers converge: Evidence from the Financial Services Modernization Act of 1999. The Financial Review, 37(1), 53–72.
Maues, J. (2013). Banking Act of 1933, commonly called Glass-Steagall. Federal Reserve Bank of St. Louis.
Rickards, J. (2012). Repeal of Glass-Steagall caused the financial crisis. U.S. News and World Report.
Create your account
Always verify citation format against your institution’s current style guide requirements.