Wednesday, October 15, 2008

A Brief Institutional History

There are a lot of things I hope to post on in the next few days, but this one begged to be first

In today's (10/15/08) issue of The Wall Street Journal, Peter Wallison of the American Enterprise makes what I consider to be a significant misstatement in his opinion piece. Early in the essay, he states that "While there has been significant deregulation in the U.S. economy during the last 30 years, none of it has occurred in the financial sector."

I would contest that claim, whatever it's based on. To go back 30 years is to start the clock in 1978. By my count, there have been at least five acts. (In fairness, Wallison does cite two of them later in his essay, but to dismiss any of these as "not significant" to the financial sector is, in my opinion, questionable.

The first act I would count as significant is the Depository Institution Deregulation and Monetary Control Act (DIDMCA) of 1980. The short explanation is that this act is allowed banks and savings and loans into each other's "businesses". In turn, this allowed S&Ls to hold assets other than mortgages; and gave access to the Fed's discount window to depository institutions that were not banks, while extending the Fed's reserve requirement to those same institutions.

The second piece of legislation that I think should be viewed as significant is the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) of 1989. It consolidated two federal S&L regulators into one and placed the combined entity within the Department of Treasury. It also established the Resolution Trust Corporation to clean up hundreds of insolvent thrifts, and expanded Fannie's and Freddie's responsibility to support mortgages for low- and moderate- income families.

The third law and the first piece of legislation mentioned by Mr. Wallison is the Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991. It strengthened the FDIC by allowing it to borrow directly from the U.S. Treasury, and to resolve failed banks by using the least-costly method available, while authorizing the FDIC to assess deposit insurance premiums according to risk undertaken by banks. (I suspect this may have provided some, if not a lot of incentive for banks to securitize risky loans. But I'm just speculating on that.)

The Riegle-Neal Interstate Banking Act (RNIBA) of 1994 is the fourth piece of legislation. It allowed banks to begin branching across state lines. If I'm not mistaken, it also allowed bank-holding companies to consolidate charters from different states into national charters. This provided impetus for some consolidation of banking in the U.S.

The final piece in my list, and the second piece of legislation cited by Mr. Wallison, is the Gramm-Leach-Bliley Financial Services Modernization (GLBA) Act of 1999. It repealed part of the Glass-Steagall Act of 1933 and allowed competition between banks, securities firms and insurance companies by allowing them to combine into single entities.

While it seems that Mr. Wallison backtracks by allowing that FDICIA and GLBA may have been significant, I would contend that the other pieces of legislation also had significant impact on the financial sector in the past 30 years. All of these changed the rules and the structure of that sector in significant ways. And by changing the rules and structure, the incentives were changed. And the new incentives rippled through the financial system, causing changes in behavior - by firms, by consumers, and by government entities.

I welcome your thoughts.

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