Deregulation of financial institutions - Business in United States of America

Deregulation of financial institutions: After World War II

Deregulation of financial institutions: Financial Crisis of 2008

The Event: Federal government’s removal or relaxation of many 1930’s restrictions on banks’ and savings and loans’ ability to branch, lend, and make interest payments

Date: Began in 1980

Place: United States

Significance: Deregulation contributed to efficiency and innovation in the financial sector, but also to economic crises. Deposit institutions became less differentiated from one another, but each offered more diverse services to business and household customers.

During the Great Depression of the 1930’s, the federal government imposed many restrictions on the conduct of banks and other deposit institutions. For banks, these fell chiefly into five categories. First, entry into banking was severely limited. Chartering authorities such as the U.S. Comptroller of the Currency (for national banks) and state banking departments made it difficult to start a new bank so that existing institutions were protected from competition. Second, types of assets were severely restricted. In general, banks were forbidden to invest in stocks or real estate directly, and loans on such collateral were subject to stringent limitations. Commercial banks were barred from engaging in investment banking (marketing new securities issues), and from providing brokerage, insurance, or real estate services. Thrift institutions were largely restricted to home mortgages and bonds.

Third, federal law gave states authority to set rules for establishing bank branches. Some states prohibited branching altogether (Illinois). Even where regulations were liberal, (California) branches were limited to one state. Fourth, ceilings were imposed on interest rates paid on deposits. No interest could be paid on demand deposits. Time deposit rates were set by the Federal Reserve under Regulation Q, and were generally held at low levels to safeguard bank profits. Finally, all deposits of Federal Reserve member banks were subject to reserve requirements set by the Federal Reserve, and required reserves were to be held on deposit with the Federal Reserve banks. Nonmember banks had much lower requirements set by state authorities.

Further Reading

• Barth, James R., R. Dan Brumbaugh, Jr., and James A. Wilcox. “The Repeal of Glass-Steagall and the Advent of Broad Banking.” Journal of Economic Perspectives 14, no. 2 (Spring, 2000): 191-204. Detailed examination of the 1999 legislation which removed barriers to the activities banks can engage in. 
• “Financial Market Deregulation.” In Economic Report of the President. Washington, D.C.: Government Printing Office, 1984. A very readable and systematic overview, stressing links to monetary policy. 
• Litan, Robert E. “Financial Regulation.” In American Economic Policy in the 1980s, edited by Martin Feldstein. Chicago: University of Chicago Press, 1994. Develops the interaction between deregulation and the thrift crisis; two commentators provide additional perspective. 
• Markham, Jerry W. A Financial History of the United States. Armonk, N.Y.: M. E. Sharpe, 2002. 3 vols. Largely chronological, this work is a gold mine of details, but not very analytical. 
• Mishkin, Frederic. The Economics of Money, Banking, and Financial Markets. 7th ed. New York: Pearson Addison Wesley, 2006. Chapter 10 of this college level text places deregulation in the context of financial innovation, regulatory policy, and the S&L crisis. 

See also: bank failures; Federal Deposit Insurance Corporation; Merger and corporate reorganization industry; Mortgage industry; New Deal programs; trickle-down theory.