Wall Street bill sweeps away stray remnant of 1933 Glass-Steagall Act

In seven simple lines buried in this year’s financial overhaul bill, lawmakers swept away one of the last vestiges of the 1933 Glass-Steagall Act that held sway over markets for decades.

The Depression-era bill is best known for separating commercial and investment banking — a wall that was effectively repealed in the late 1990s. Liberal Democrats, consumer advocates and a few Republicans pushed unsuccessfully this year to draw that line once more as part of the Wall Street bill.

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But Glass-Steagall had another core pillar: a ban on banks paying interest on checking accounts. Banks and lawmakers chipped away at the ban and other interest rate restrictions over the years, to the point that it basically only barred payments on business accounts. The Dodd-Frank Act did away with the rule entirely.

“This really is the last remnant of that Depression edifice,” said Vincent Reinhart, a former senior Federal Reserve official. 

Wayne Abernathy, executive vice president at the American Bankers Association, said the provision “is clearly an anachronism.”

The original goal of the provision was to steady the banking industry during the turmoil of the Great Depression, which saw thousands of banks fail in the early 1930s.

Without a ban, the thinking went, banks could run wild by competing to pay the highest interest rate to attract customers. Keeping interest rates low and steady was also an incentive to banks to lend instead of parking their own money with other banks to receive interest.

The Federal Reserve implemented the ban through “Regulation Q.”

The restrictions and ceilings on interest rates were changed several times in the 1960s, but the biggest shift came in 1980.

Interest rates rose sharply in the late 1970s and a range of new financial products sprang up challenging the banking industry. Money-market mutual funds quickly became a major force in the financial world, while banks were limited in what they could pay in interest.

In 1980, Congress decided to do away with almost all of the policy on interest rate ceilings. In 1982, lawmakers pushed to speed up the phase-out.

Still, banks were not able to pay interest on business accounts, which now represent about 8 percent of total bank profit, according to Treasury Strategies, a consulting firm. The House took up legislation several times to remove the provision. As an assistant Treasury secretary in 2003, Abernathy testified that the prohibition on interest payments was a “relic of the Great Depression.” The George W. Bush administration wanted a repeal, but the Senate never found a way to pass one.

Lawmakers barely debated the repeal in public over the last two years. The Independent Community Bankers of America (ICBA), a powerful trade 

association of 5,000 smaller banks, did not have a formal position on it.

“Some are uncomfortable because it would raise their costs,” said Steve Verdier, executive vice president at ICBA. “Others were hoping to use it as a competitive tool.”

The American Bankers Association (ABA) wanted a repeal, but it was never among the association’s top priorities in the financial bill, which touched nearly every part of the regulatory landscape.

On Dec. 10, Rep. Scott Murphy (D-N.Y.) pushed for the change on the House floor. “This adversely affects our small businesses and keeps them from building their business,” he said. “Now, as we are fixing some of the issues we have with our regulatory system, is the right time to get rid of that.”

The change was added to the financial bill as the very last section when it passed the House. The Senate didn’t take it up when it passed its version. During negotiations between the House and Senate to reconcile the bills, the repeal found its way back into the legislation, this time in the middle, near much more contentious provisions.

“It’s been on the legislative to-do list for some period of time, but it never really found a vehicle that will allow it to be actually enacted into law,” said Charles Horn, a partner at the Mayer Brown law firm. “Dodd-Frank proved to be the vehicle.”

The repeal takes effect in July 2011.

Financial industry lawyers and experts are not sure how much of an impact the repeal will have.

“I would say that in theory it could have some far-reaching impact,” said Scott Cammarn, of Cadwalader, Wickersham & Taft LLP. 

George Kaufman, professor at Loyola University in Chicago, said he doubts it will have much of an effect.

“It just cleans things up,” he said.