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 also 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.
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
The focus of deregulation was the
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
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
In 1994, the
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 gets 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.
Financial deregulation was heavily criticized as contributing to the
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.
Federal Deposit Insurance Corporation
Financial crisis of 2008
Merger and corporate reorganization industry
New Deal programs
Savings and loan associations