The United States has long scrutinized how banks and savings institutions attract customers with lending rates and the interest-bearing capacities of accounts offered for checking and saving. The safety of consumer accounts played a major role in shaping the regulatory landscape of US banking and finance following the Great Depression, especially as concerns of safety and stability were elicited in the Banking Act of 1933, otherwise known as the Glass-Steagall Act. What happens, however, when the legislated interests of consumer protection, safe banking and monetary control backfire when put under pressure and actually become detrimental to the health of the US financial system?
As it turns out, quite a bit emerged from the crisis that spread through the US economy in the 1970s that commercial banks, mutual savings banks and thrifts endured with difficulty: not only did the government pass some of the most bipartisan measures of deregulation in the industry to date to save these institutions from collapse, but financial innovation, changes to the membership structure of the Federal Reserve system and a huge consolidation within the financial services industry resulted from the crisis through a process of comprehensive deregulation and better accessibility for consumers to find ways to save and borrow.
The Great Depression and the Imposition of Regulation Q
Financial activity prior to Wall Street’ s collapse in 1929 was characterized by prevailing notions of fiduciary recklessness, financial institutions gambling with investor money and lax protocols for oversight within the banking industry— all of which could have been major contributing causes to the Depression itself. Regardless of the reasons, Congress passed the Glass-Steagall Act in 1933, which sought to rein in risky activity bankers had become famous for by breaking up retail banks and investment banks. It also established a mechanism known as Regulation Q, among other provisions.
Previous page: Past chairmen of the Council of Economic Advisers testify before the Senate Banking Committee on anti-inflation policies, 1980.
Regulation Q served as a ceiling that banks, thrifts and mutual savings institutions were required to observe when setting interest rates they could offer to consumers seeking both time accounts and demand accounts with different institutions. This emerged as a component of Glass-Steagall due to the belief that prior to the Depression, many banks were competing with each other for customer deposit accounts, which with respect to their ability in managing risk for their liabilities, created instability. Moreover, if interest rate ceilings were set, the Federal Reserve would have a better grasp on the macroeconomic impacts stemming from the loans issued in the housing market and the broader availability of money being loaned.
By imposing ceilings at different levels, the Federal Reserve hoped to induce consumers to keep their savings accounts at thrifts while simultaneously holding checking accounts at commercial banks. Starting in 1966, the Fed imposed specific ceilings on interest rates above the current market rate; given that interest paid on various account types had been increasing, these ceilings applied to accounts offered at thrifts, credit unions, commercial banks, savings & loan associations and mutual savings banks alike. So, what went wrong?
Economic Malaise, Instability and Innovation in the 1970s
After the Federal Reserve imposed interest rate ceilings, savers and borrowers alike began to suffer from the fallout of the ill-timed restrictions’ impact on their finances, as well as the prevailing macroeconomic conditions that defined much of the 1970s. In the early part of the decade, inflation began to spike as the domestic oil industry sputtered and the global economy reeled from the Organization of Petroleum Exporting Countries( OPEC)’ s decision to embargo shipments to several western countries— starting an oil crisis that sent the inflation rate soaring above 5 % in countries like the United States and the United Kingdom.
As the economic downturn worsened in the later part of the decade, consumers began to feel the impact this had on their deposits with banks, thrifts and savings
& loans associations, given that the rates imposed on time deposits( accounts for certificates with fixed maturities) were not bearing interest at a rate that at certain points was competitive with inflation and turned into an unintended form of financial repression.
In particular, thrifts were put at a disadvantage; not only were they not allowed to offer interest on certain accounts for customers, but also the model of business they utilized relied heavily on short-term deposits to finance the longer maturity, higher yield time deposits that customers held with them and ceilings on short-term accounts disadvantaged short-term savers. Additionally, the flaw in the design for interest rate ceilings emerged as consumers realized that borrowers did not benefit as they were supposed to, given that lenders reduced the mortgages issued and indirectly curbed housing growth.
Another prevailing problem at this time was the relationship that many financial institutions maintained with the Federal Reserve itself, and whether they were governed under state charters or federal charters. While federally chartered institutions had access to the Fed to lend and loan, state-chartered companies were able to keep reserves on a state level which they earned interest on— something Federal Reserve requirements struggled to make enticing. To make matters worse, the Federal Reserve federal funds rate increased substantially over the course of the 1970s, leading smaller banks, thrifts, savings & loans associations and mutual savings banks at a disadvantage for borrowing and lending.
As such, many of the banks that had originally registered with the Federal Reserve left to evade the interest restrictions and reserve disadvantages, leaving Federal Reserve membership in shambles. After World War II, 50 % of banks registered with the Federal Reserve Bank as members held approximately 90 % of the nation’ s cash deposits. By the mid-1970s, roughly 40 % of the nation’ s banks maintained Federal Reserve membership, and the share of deposits they represented on the whole dropped to 60 %.
Interestingly, the conundrum that financial institutions faced in the wake of inflation, Federal Reserve interest rate hikes, and ceilings on deposit accounts
30 FINANCIAL HISTORY | Summer 2016 | www. MoAF. org