Re-Regulate the Banks

Just the title of this piece is going to cause some of my friends who are opposed to most regulations to go into a minor form of shock. I will attempt to address their concerns while explaining what I mean by “re-regulation,” the reasons behind “re-regulating” the banks, and what this issue has to do with the concepts that I have outlined here.

First, let me supply some history. This is going to sound very old and tedious, but bear with me.  In 1864, Congress passed the National Currency Act which prohibited all branching, either in-state or out of state branching of banks. It effectively prohibited interstate banking.  There were subsequent federal laws that returned back to the states the ability to regulate in-state branching. Believe it or not, the law that followed the National Currency Act, the McFadden Act of 1927  was still in effect until the 1994 Riegle-Neal Interstate Banking and Branching Efficiency Act which provided the basis for a true national banking system. A large number of loosening of regulation had occurred in the interim, but Riegle-Neal was the nail in McFadden’s coffin. That means up until as recent as 1994, banks were somewhat prohibited from operating across state lines. I point this out only to note that what I will be proposing is not a total impossibility.

Second, the Banking Act of 1933 prohibited banks from engaging in both commercial and investment activity. This regulation was in place, though in a dilapidated form, until the Gramm-Leach-Bliley Act of 1999 which totally deregulated the former restrictions and went even further in permitting banks to underwrite insurance, invest in real estate and other similar investment activities.

Free-market types hailed these two deregulations as creating true competition among banks and savings and loans and insurance companies, with increased choices for consumers. The spreading of risk across state lines, and now throughout the world was said to decrease the possibility of bank failures. I don’t think I need to go into the fact that instead of decreasing the possibility of bank failures, these de-regulations increased the need for government bailouts.  However, the figures also show the opposite in terms of competition. Between 1984 and 2009 the number of FDIC backed banks was cut in half. This means that the banking system has become more centralized and there is less of a market for differences in rates. It also means that the decisions are increasingly made, not on a local level, but at a level where there is no relationship between the banker and the borrower.

I start the first of my policy ideas off with banking because I recognize that the central driving force in our society is money.  When local banks failed, there is no doubt that it was devastating to a community. However, it was the community that suffered through it. With the creation of the Federal Deposit Insurance Corporation, the community’s suffering was eased due to a small sacrifice on the part of other communities in contributing to the FDIC.  Today, when a nationalized intertwined commercial, investment and insurance provider fails, the country suffers and there is no way to ease that suffering. Instead the entire country is forced to suffer more by increasing the burden because of the extra money that must be paid into the FDIC.

I am not hear trying to say that the FDIC is either a good or bad thing. What I am saying is that we should re-regulate the banking industry in such a way that the banks are regulated by the states, are not permitted to bank across state lines, and commercial and investment banking (not to mention insurance and real estate speculation) are separate.

These type of regulations would accomplish a few things. First, it would be forced federalism and maintain and permit different types of regulations by each state in relation to what the individual states felt were the best regulations to have or not have based on their priorities. Second, it would put capital back in the hands of those in the community who were best suited to invest it rather than placing it simply in the hands of the financial power structures, formerly in New York City and now in Washington D.C.. Localized capital means localized risk. However, localizing the risk minimizes it in relation to the nation. Third, it would allow those in charge of the regulations to easily place blame when a mis-hap occurred.  

In response to the libertarian arguments about the regulation decreasing the open market, I would retort that it was the national free-market thinking that begged Washington’s intervention in the first place. Now with a national “free and competitive” banking system, those in charge nationally are seeking new types of powers for much more intrusive interventions than could have been carried out when banking interests were scattered and decentralized.

The practical effects of these very simple regulations would be to allow those who could actually afford mortgages, obtain them, while forcing those institutions who give out mortgages to be held accountable for their decisions instead of selling bundled mortgage backed securities to some distant financial institution to purchase to back pensions. Secondly, it would decentralize the banking structure to combat the increasing concentration of money. Finally, a relationship between borrower and lender would once again be established in order to foster a truly “free market” with a greater amount of first hand intelligence aiding investments.