Deregulation of financial institutions: After World War II - Business in United States of America
Deregulation of financial institutions: Financial Crisis of 2008
Interest rates were extremely low during the 1930’s and 1940’s, then they trended steadily upward. Reserve requirements were held at high levels during the inflationary conditions of 1942-1952. Requirements softened as the economy returned more nearly to normal. In 1959-1960, banks were allowed to count vault cash toward their required reserves. Banks experimented with holding companies as a way of participating in nonbank business activities and operating the equivalent of branches across state lines.
However, it was the severe inflation that erupted during the late 1960’s that precipitated serious deregulation. Market interest rates rose to unprecedented high levels—far beyond the ceiling rates permitted on deposits. In 1966, Congress extended deposit-rate ceilings to thrift institutions to try to forestall a bidding war for deposits. The invention of money market mutual funds in 1971 provided savers with safe, liquid, high-interest assets, and deposit institutions found themselves losing time and savings deposits. Problems were especially severe for savings institutions, which held most of their funds in mortgages or long-term bonds. Deposit withdrawals pressured the institutions to try to sell off assets, but those asset prices were falling as interest rates rose.
The focus of deregulation was the Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA). The law and Federal Reserve actions pursuant to it brought these deregulations: All banks were brought under Federal Reserve rules for reserve requirements, but these were substantially reduced. Requirements on time and savings deposits were gradually eliminated by 1986. Checking deposits required a 10 percent reserve, but most corporate checking deposits escaped this by using sweep accounts. Ceiling interest rates under Regulation Q were phased out. Interest could now be paid on checking accounts of nonbusiness depositors. Savings institutions were now able to offer checking deposit services.
Though not an instance of deregulation, another provision of DIDMCA raised the coverage of deposit insurance of banks and thrift institutions to $100,000. This enabled deposit institutions to cash in on the two major deregulatory aspects of the law. They began issuing large, fully insured certificates of deposit (CDs), which they sold in the open market.
In 1982, the Garn-St. Germain Act greatly liberalized the range of permitted assets for thrift institutions (savings and loans, or S&Ls, and mutual savings banks). These were now permitted to have as much as 40 percent of their assets in commercial real estate loans, 30 percent in consumer loans, and 10 percent in commercial loans and leases. The 1982 law authorized banks and thrifts to offer money-market deposit accounts, designed to compete with money-market mutual funds.
The 1982 law was undertaken in an effort to rescue savings and loan associations from insolvency resulting when the market value of their mortgage loan portfolios declined. Perhaps half the S&Ls in the country were technically insolvent by 1982. The result was that many S&Ls undertook very risky lending and failed. In 1989, the Financial Institutions Reform, Recovery, and Enforcement Act undertook to clean up the mess, at a cost to the public of some $150 billion. Most of the 1982 liberalizations of the thrift industry were repealed.
In 1994, the Interstate Banking and Branching Efficiency Act removed the previous restrictions on interstate bank branching. In 1999, the 1933 prohibitions against banks engaging in nonbank financial business activities were largely eliminated.
As a result of all these laws, the financial system changed dramatically between 1975 and 2000. Legislated distinctions among different deposit institutions largely disappeared. A massive wave of bank consolidation reduced the number of institutions. In 1970, there were more than 13,000 commercial banks and more than 5,000 S&Ls. By 2006, there were about 7,400 commercial banks and 1,300 thrift institutions.
Deregulation is very mixed reviews from financial experts. It opened the financial world to innovation and competition, paving the way for fuller participation in the global economy. However, it overwhelmed management and regulatory competence, as was evident in both the S&L crisis of the 1980’s and the subprime mortgage crisis of 2007-2008.