Financial History Issue 118 (Summer 2016) - Page 33

The Beginning of Bank Deregulation in Post-War America Realizing the need to act swiftly, the Carter administration summoned a task force to review the state of the banking, thrift and savings & loan associations’ health in the US, as well as how to address these rising problems affecting the economy. In August 1979, the administration’s Inter-Agency Task Force on Regulation Library of Congress spurred companies to adopt financially innovative investment vehicles that utilized a mixture of regulatory “creative compliance,” as well as financial engineering to generate better returns for their customers and to attract new business in the face of rising costs. Principal among the emerging products were the negotiable on withdrawal (NOW) accounts and the money market certificate. NOW accounts benefitted depositors by acting like time deposits, but banks, thrifts and savings & loans associations could offer transaction accounts with interest, which skirted the Regulation Q requirements that barred offering interest on demand accounts (e.g. deposit accounts without fixed maturities). Because these were not subject directly to the interest rate ceilings under Regulation Q, customers benefitted by way of higher yields and having the ability to withdraw money on demand. On the other hand, money market certificates emerged as a way to earn favorable, market-based yield with fixed maturity deposits in fixed sums. These instruments gained popularity due to the fact that they issued an interest rate pegged to sixmonth Treasury certificates with the same maturity date and a minimum deposit of $10,000. Similarly, mutual funds — which were competing with banks and thrifts for investor business from would be depositors-turned-savers, began offering money market mutual funds, which pooled investor cash into a fund to generate higher yields on government bonds, commercial paper and other forms of debt without the oversight (or FDIC protection) of the government. In the face of the rising pressure that banks and thrifts faced against inflation, financial innovation and regulation, the government needed to act in order to right the course moving forward. This is not only a significant step in reducing inflation, but it’s a major victory for savers, and particularly for small savers. It’s a progressive step for stronger financial institutions of all kinds… — President Jimmy Carter Q offered an official report which recommended several key measures the government should effectuate through legislative means, including liberalizing the market for higher yielding account products, increasing Federal Reserve oversight of financial institutions and lifting interest rate ceilings. Specifically, the report noted the importance of the financial innovation taking place in the market, stating: Traditionally, savings institutions relied on their interest-rate differential on deposits to offset their inability to offer transaction accounts… The attractiveness to the public of interest-bearing transaction accounts has been amply demonstrated. Indeed, the very rapid growth of the money market mutual funds is attributable in part to the fact that balances can be withdrawn by means of a check-like investment. These recommendations passed both the House and the Senate, and they were signed into law on March 31, 1980 by President Carter as the Depository Institutions Deregulation and Monetary Control Act (DIDMCA). Upon signing the bill, President Carter noted the impact the measures would have on easing savings capacities for smaller investors, access to financing on behalf of banking and savings institutions and liberalization of the financial services offerings available to the industry. He stated: This is not only a significant step in reducing inflation, but it’s a major victory for savers, and particularly for small savers. It’s a progressive step for stronger financial institutions of all kinds…our banks and savings institutions are hampered by a wide range of outdated, unfair and unworkable regulations. Especially unfair are interest rate ceilings that prohibit small savers from receiving a fair market return on their deposits. It’s a serious inequity that favors rich investors over the average savers. Today’s legislation will gradually eliminate these ceilings and allow, through competition, higher rates for savers. The act effectuated several key changes which took place over the following several years. First, interest rate ceilings via Regulation Q were gradually lifted until 1986, when they were completely removed. Financial institutions of all types could now offer the NOW account, providing an alternative to traditional demand and time deposit accounts. All financial institutions that accept deposits were required under the Monetary Control Act to maintain reserves with the Federal Reserve, which provided them access to funds and discounts, albeit with some cost when compared against market rates. But did these changes actually help? As the DIDMCA went into effect, inflation in the US reached the incredible height of 13.5%, and the Federal funds rate reached 18.90% by the end of the year. Even as thrifts, savings & loans associations and mutual savings banks were able to offer a more diverse range of accounts to consumers — in addition to taking on larger investments » continued on page 39  |  Summer 2016  |  FINANCIAL HISTORY  31