A Short History of Financial Deregulation

A Short History of Financial Deregulation in the United States

Glass-Steagall Act (1933): A law enacted during the Great Depression to separate commercial banking ( taking deposits and making loans) from investment banking ( trading and securities). This was meant to prevent banks from taking excessive risks with depositors' money.

Repeal of Glass-Steagall: Happened in 1999 with the Gramm-Leach-Bliley Act. IT allowed banks to combine commercial and investment activities again, which some argue contributed to the 2008 financial crisis.

Background Summary:

• Early financial regulation included caps on interest rates to protect borrowers
• The Federal Reserve System was created in 1914 to stabilize the economy, control money supply, and prevent baking cruises
• The Great Depression brough stricter regulations, such as the Glass-Steagall Act, Which separated banking activities and created deposition insurance to protect consumers

This section highlights how regulation evolved to address past crises like the Great Depression. It shows the balancing act between controlling financial risk and fostering innovation Early regulation were reactive, responding to specific crises setting the stage for later deregulation efforts.

Removing Interest Rate Ceilings

• Regulation Q, in 1933, capped interest rates on saving accounts
• In the 1970s, inflation made these caps problematic, leading to their removal under Depository Institutions Deregulation and Monetary Control Act of 1980.
• Spurred growth of new financial produce like money market funds, which offered higher returns without restrictions

The removal of interest rate ceilings encouraged competition among financial institutions but also led to riskier financial practices. This deregulation shifted the financial landscape, allowing innovative produce to thrive while increasing system risks.

3. Repealing Glass-Steagall

Summary:

• The Glass-Steagall Act prohibited banks from engaging in both commercial and investment banking.
• By the 1980s and 1990s, banks lobbied to repeal it, arguing that it hindered their competitiveness in a global economy.
• The Gramm-Leach-Bliley Act of 1999 repealed Glass-Steagall, allowing banks to diversify and merge.
• Critics argue that this deregulation contributed to the 2008 financial crisis by enabling risky banking practices.

Analysis:

Repealing Glass-Steagall was a turning point, signifying a shift toward deregulation and greater consolidation in the banking industry. While it boosted the competitiveness of U.S. banks, it also blurred the lines between different types of banking activities, creating potential for conflicts of interest and systemic risks.

4. Hands-Off Regulation

Summary:

• The 1990s saw a surge in new financial instruments, particularly derivatives, which posed challenges for regulators.
• Efforts to regulate derivatives were resisted by powerful financial interests and government officials.
• The Commodity Futures Modernization Act of 2000 exempted derivatives from regulation, contributing to the buildup of systemic risks in the financial sector.

Analysis:

• This section underscores the risks of minimal regulation in complex financial markets. The hands-off approach enabled rapid innovation but also allowed hidden risks to accumulate, ultimately contributing to financial instability, as seen in the 2008 crisis.

Derthick and Quirk chapter from Politics of Deregulation

The Politics of Deregulation explores how and why significant deregulation occurred in the U.S. during the late 20th century. The article examines the roles of political leadership, independent regulatory commissions, and economic analysis in driving reforms. It highlights how deregulation was made possible by a combination of public support, expert advocacy, and institutional dynamics, while also addressing the challenges posed by interest groups and the fragmented U.S. political system.

Role of Independent Regulatory Commissions:

• Commissions like the Civil Aeronautics Board (CAB) and Interstate Commerce Commission (ICC) led reforms by using their broad statutory powers to bypass Congressional gridlock.

Importance of Economic Analysis:

• Economists provided evidence-based arguments for deregulation, showing how regulations created inefficiencies and raised costs without benefiting the public.

Political Leadership and Timing:

• Leaders like President Ford and Senator Kennedy prioritized deregulation when public and political conditions were favorable.

Public Support and Symbolism:

• Rhetoric like "cutting red tape" helped gain public backing by framing deregulation as a way to lower prices and reduce government interference.

Challenges to Reform:

• Industries and labor unions opposed deregulation, but fragmented organization and strong public support weakened their resistance.

Examples of Deregulated Industries:

• Airlines: Lower fares and more competition.
• Trucking: Competitive rates and routes.
• Finance: Removal of interest rate caps but increased risks.

Vietor article, “Regulation American Style,”

The New Deal established government oversight in sectors like banking, transportation, and labor, addressing market failures and creating safety nets.

1. Historical Foundations of Regulation

• Regulation began during the Progressive Era (early 20th century) to control the economic and political power of monopolies and large corporations.
• The New Deal of the 1930s expanded regulation to address market failures and stabilize industries like finance, transportation, and labor during the Great Depression.

2. Criticism of Regulation in the 1970s

• By the 1970s, regulation faced growing criticism for being inefficient, outdated, and burdensome, particularly in industries like transportation (airlines and trucking) and energy.
• Overregulation was linked to rising costs, stifled innovation, and inflationary pressures, prompting calls for reform.

3. Shift to Deregulation

• Deregulation emerged in the 1970s and 1980s to address inefficiencies and enhance global competitiveness.

• Key sectors like airlines, trucking, telecommunications, and finance underwent significant deregulation, aiming to:

• Lower consumer costs.

• Foster competition and innovation.

• Reduce government interference in the economy.

4. Role of Consumer and Environmental Movements

• Social movements in the 1960s and 1970s expanded the scope of regulation beyond economic issues to include environmental protection (e.g., Clean Air Act) and consumer safety.

5. Consequences of Deregulation

• Positive Outcomes:

• Increased competition led to lower prices and greater innovation in many industries.

• Negative Outcomes:

• Job losses due to industry restructuring.

• Industry consolidation, which sometimes reduced competition over time.

• Financial instability caused by the removal of safeguards, such as interest rate caps.

6. Regulation in the 21st Century

• The article suggests that deregulation created both opportunities and challenges. While it modernized industries and fostered competition, it also highlighted the need for balanced oversight to prevent systemic risks.

Takeaways

• Regulation in the U.S. evolved to address economic and social issues, but its rigid structure eventually faced backlash.
• Deregulation brought economic benefits but exposed industries to new vulnerabilities, such as financial crises and market monopolization.
• Balancing regulation and market freedom remains a central challenge for policymakers.

Explore the timeline of financial deregulation in the United States, starting with the Glass-Steagall Act of 1933 and its repeal in 1999. Understand how these changes have influenced the banking system and contributed to financial crises, emphasizing the balance between regulation and risk. This quiz provides insights into the impact of historical financial laws.