Financial History Issue 118 (Summer 2016) | Page 32

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
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