Sec. 2. Findings and purpose
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Congress finds that— in response to a financial crisis and the ensuing Great Depression, Congress enacted the Banking Act of 1933, known as the Glass-Steagall Act , to prohibit commercial banks from offering investment banking and insurance services; a series of deregulatory decisions by the Board of Governors of the Federal Reserve System and the Office of the Comptroller of the Currency, in addition to decisions by Federal courts, permitted commercial banks to engage in an increasing number of risky financial activities that had previously been restricted under the Glass-Steagall Act, and also vastly expanded the meaning of the business of banking and closely related activities in banking law; in 1999, Congress enacted the Gramm-Leach-Bliley Act , which repealed the Glass-Steagall Act separation between commercial and investment banking and allowed for complex cross-subsidies and interconnections between commercial and investment banks; former Kansas City Federal Reserve President Thomas Hoenig observed that with the elimination of Glass-Steagall, the largest institutions with the greatest ability to leverage their balance sheets increased their risk profile by getting into trading, market making, and hedge fund activities, adding ever greater complexity to their balance sheets. ; the Financial Crisis Inquiry Report issued by the Financial Crisis Inquiry Commission concluded that, in the years between the passage of Gramm-Leach Bliley and the global financial crisis, regulation and supervision of traditional banking had been weakened significantly, allowing commercial banks and thrifts to operate with fewer constraints and to engage in a wider range of financial activities, including activities in the shadow banking system. .
The Commission also concluded that [t]his deregulation made the financial system especially vulnerable to the financial crisis and exacerbated its effects. ; a report by the Financial Stability Oversight Council pursuant to section 123 of the Dodd-Frank Wall Street Reform and Consumer Protection Act states that increased complexity and diversity of financial activities at financial institutions may shift institutions towards more risk-taking, increase the level of interconnectedness among financial firms, and therefore may increase systemic default risk.
These potential costs may be exacerbated in cases where the market perceives diverse and complex financial institutions as ‘too big to fail,’ which may lead to excessive risk taking and concerns about moral hazard. ; the Senate Permanent Subcommittee on Investigations report, Wall Street and the Financial Crisis: Anatomy of a Financial Collapse , states that repeal of Glass-Steagall made it more difficult for regulators to distinguish between activities intended to benefit customers versus the financial institution itself.
The expanded set of financial services investment banks were allowed to offer also contributed to the multiple and significant conflicts of interest that arose between some investment banks and their clients during the financial crisis. ; the Senate Permanent Subcommittee on Investigations report, JPMorgan Chase Whale Trades: A Case History of Derivatives Risks and Abuses , describes how traders at JPMorgan Chase made risky bets using excess deposits that were partly insured by the Federal Government; in Europe, the Vickers Independent Commission on Banking (for the United Kingdom) and the Liikanen Report (for the Euro area) have both found that there is no inherent reason to bundle retail banking with investment banking or other forms of relatively high risk securities trading, and European countries are set on a path of separating various activities that are currently bundled together in the business of banking; private sector actors prefer having access to underpriced public sector insurance, whether explicit (for insured deposits) or implicit (for too big to fail financial institutions), to subsidize dangerous levels of risk-taking, which, from a broader social perspective, is not an advantageous arrangement; and the financial crisis, and the regulatory response to the crisis, has led to more mergers between financial institutions, creating greater financial sector consolidation and increasing the dominance of a few large, complex financial institutions that are generally considered to be too big to fail , and therefore are perceived by the markets as having an implicit guarantee from the Federal Government to bail them out in the event of their failure.
The purposes of this Act are— to reduce risks to the financial system by limiting banks’ ability to engage in activities other than socially valuable core banking activities; to protect taxpayers and reduce moral hazard by removing explicit and implicit government guarantees for high-risk activities outside of the core business of banking; and to eliminate conflicts of interest that arise from banks engaging in activities from which their profits are earned at the expense of their customers or clients.