"In order to begin to understand what happened, it would be quite useful to look back into the past. A "view of the forest" from the historical perspective could help policymakers formulate better policies in the future.
The Glass Steagall Act of 1933
The 1933 Glass Steagall Act of the US Congress was a reaction to the widespread bank failures that accompanied the Great Depression. It was observed that banks invested their deposits in the stock market, underwrote new issues for distribution to the public and lent to the companies that issued stocks that the banks underwrote. It is, therefore, easy to imagine how banks have failed when the prices of stocks dropped massively during the Great Depression.
The Glass Steagall Act separated commercial banking from investment banking. Commercial banks could take deposits but could not do underwriting except for US government securities. Under the Act, no more than 10 percent of a commercial bank's income could come from securities. Investment banks could do securities underwriting and broking but could not take deposits. The Act also created the deposit insurance system to protect the deposits of the public.
The rationale for the Act is quite clear from the historical perspective. It was to prevent banks that were taking deposits from the public from putting these deposits at risk by taking big positions in the stocks of companies. At the same time, it prevented conflicts of interest in banks that were underwriting stocks of companies for public distribution and lending to those companies at the same time. It is like a bank selling a company's stocks to the public so that it could be repaid."
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