A History of America's Banking System: Is the one we have the one we need? (Re-posted from Tremr 2016)

America's banking system is touted as one of the most advanced in the world. Many other nations have duplicated the free movement of capital throughout the nation and heavy branch presence. However, in the wake of the Global Financial Crisis of 2007-09, much speculation has been cast upon the body of regulation ( or lack thereof) that has allowed banks to become too big to fail and engage in non-depository activities. But what has contributed to the banking system we use today, and is the one we have now the best one for the general public? 

When looking at the American banking system, one has to look at its inception in 1782 with the chartering of the Bank of North America. It was the first central bank of the United States, and after shares were told to the public, it became the country's first initial public offering. However, the Bank of North America started out as a private business which posed the problem of conflict of interest. Thus, in 1791, the first official central bank was established: Bank of the United States. However the charter was a twenty-year one, and due to congressional gridlock, the charter was allowed to expire. I suppose nothing has changed. 

In 1816, the Second Bank of the United States was chartered. It's twenty-year charter lapsed, once again, as President Andrew Jackson vetoed its renewal in 1832. 

During this time, banks and states could print their currencies. There was no nationally accepted currency. Going from New York to California was like going to a different country, and there was no guarantee your US dollar would be accepted. The National Bank Act of 1863 remedied this. It established the Office of the Comptroller of Currency which regulated the printing and minting of dollars and coins. The Act uninformed the country's currency and fostered interstate trade.


Despite this, there was still the issue of panic withdrawals. The banks were not required to keep reserves and had no system of lending that was uniform amongst them. Too many withdrawals could cause an illiquidity crisis that could ultimately cause bank insolvency. 

The banks needed a regulatory body to manage withdrawals and offer security to savers. Thus, in 1913, the Federal Reserve Act of the same year formed the Federal Reserve system that is in the United States today. Signed into law by President Woodrow Wilson, the act gave the Federal Reserve central bank rights to minting money, established the Federal Reserve as a lender of last resort to banks with liquidity issues. It also enforced new reserve requirement ratios of cash that banks must keep on hand at all times to satisfy withdrawals. 

The year 1927 saw the passing of the McFadden act which strove to outlaw interstate baking activity. By doing so, state-chartered banks would have no competitive edge over nationally chartered banks or vice versa. All national banks were subject to the laws of the states in which they decided to establish branches.

Then came The Great Depression, one of the world’s biggest economic meltdowns to date. There was the stock market crash of 1929 and severe blows to income tax revenue for governments. With this, also came individuals, who due to fears of inflation and the security of their banks, would run to the bank in a panic to withdraw their funds. These withdrawals happened in droves which even the thirty-year-old Federal Reserve could not satisfy by lending to the banks. Thus, the Glass-Steagall Act of 1933 came into being. The Act enabled governments to insure deposits via the Federal Depositors Insurance Corporation. This entity offered depositors confidence that even if their bank were to become insolvent, their money would be insured by the federal government. The Glass-Steagall Act also noticed the conflict of interest that banks had when they were both depository institutions and insurance or securities firms. Therefore, it also strove to remove the banks from non-balance sheet profitable activity such as securities trading and consultancy. 

Banks lobbied against the restriction of profitable activity the Glass-Steagall Act put on them, and by 1956, they found a way around it by establishing bank holding companies which would provide non-banking financial services such as wealth management, brokerage and credit cards via a separate umbrella company that was still affiliated with the bank. 

The regulations were fine, but being subject to regulation by the Federal Reserve was optional for banks.  With such restrictive policies meddling in profits, only 45% of banks opted into being regulated by the Federal Reserve. This meant that the Federal Reserve had no more than rudimentary influence over half of the banks in the United States. To solve this, the Depository Institutions Deregulatory and Monetary Control Act of 1980 put all banks under the control of the Federal Reserve. This also gave banks more flexibility in the services they could offer with regards to credit and raised the Federal Deposit Insurance from $40,000 to $100,000. 

Throughout the 1980s there were many bank failures and economic issues. Therefore the year 1994 brought the Reigle-Neal Act which repealed the McFadden Act. Lobbied for by banks, this allowed banks to conduct business from state to banks and also allowed bank consolidation activities where bigger banks could buy other financial institutions to ease bank insolvency issues. 

The 1990s brought more bank lobbying for greater freedom. By 1999, the Gramm-Leach-Bliley Act was passed. It repealed the Glass-Steagall Act and paved the way for what we know now as “big banking.” More mergers and acquisitions took place, and banks could then embark on more commercial activities and financial activities. 

The Global Financial Crisis of 2007-09 showed the drawbacks of such lackluster control over banking as bad debt, and reckless behavior by bankers caused one of the biggest financial meltdowns since the Great Depression. In response, 2010 saw the Dodd-Frank Wall Street Reform and Consumer Protection Act. Legally, the government now had a right to be more hands-on in the running of key establishments to prevent financial institutions from engaging in the behavior which caused the meltdown in the first place.

The Dodd-Frank Act also established new committees such as the Financial Stability Oversight Council and Orderly Liquidation Authority to monitor the performance of large companies and provide money to assist with liquidity issues should the bank not have enough reserves. The Consumer Financial Protection Bureau was established to prevent predatory mortgage lending and decrease incentives for mortgage brokers to engage in subprime mortgage lending in exchange for high possible returns. 

Some argue that this act is too little too late and comprises of regulations that should have been common sense since the advent of banking centuries ago. Banks are as profitable as they were before and just “keeping a close eye on them” may not be as good of a deterrent as restricting them from activities in which they have a conflict of interests. It does not break up the banks to avoid "too big to fail" status or increase the penalties for executives found engaging in bad banking.

From the 18th century to now, the strength of regulation fluctuated and the number of banks has steeply declined. This is due to a mixture of deregulation before the Global Financial Crisis and heavy corporate consolidation afterward. This has culminated in a system where, as of the first quarter of 2013, 90 (of the reported 6,048 banks in the country) own 82.6% of all of the $13.4 trillion of assets in the US banking system. As of the third quarter of 2015, the number of banks has sunk to just under 5,500. This inequality of power in the industry leads to less competition which hampers the financial wellbeing of the consumers ( those of us who save and borrow).

The McFadden Act, as mentioned earlier, made small banks the monopolies in their geographical jurisdictions; however, the system we have now allows big banks to swallow up their competitors, thus decreasing competition on the whole as well. 

Bernie Sanders aims to reinforce the Glass-Steagall Act to enforce more strict management of what banks can or cannot do. He wants to break up big banks and impose a blockage between investment and commercial banks. Depository institutions acting as both is an environment ripe for corruption and irresponsible behavior amongst bankers. Sanders said in a press conference in July:

"If we are truly serious about ending too big to fail, we have got to break up the largest financial institutions in this country. Allowing commercial banks to merge with investment banks and insurance companies in 1999 was a huge mistake. It precipitated the largest taxpayer bailout in the history of the world. It caused millions of Americans to lose their jobs, homes, life savings and ability to send their kids to college,” said Sanders, who said that change in the financial world “substantially increased wealth and income inequality.Sixteen years ago, I predicted that such a massive deregulation of the financial services industry would seriously harm the economy. I would give anything to have been proven wrong about this, but unfortunately, what happened seven years ago was even worse than I predicted."

In contrast, Hilary Clinton has said that she will not support putting Glass-Steagall back into law.

Is the banking system we have now the best one on the books? The Global Financial Crisis proved that it is not. However, we have yet to find the sweet spot between banks conducting their business efficiently and regulation that prevents them from performing their business with conflicts of interest. 

George-Ann Ryan