Restructuring U.S. federal financial regulation

Contemporary Economic Policy, July, 2007 by Rose M. Kushmeider

Over the years, a number of those opposed to regulatory restructuring have argued that--despite the inefficiencies resulting from a multiplicity of regulators--the current system promotes innovative approaches to regulation. The claim is that the current system, in effect, maintains a degree of checks and balances among regulators and probably results in more opportunities for industry innovation and change than would a monolithic regulatory structure. In addition, the Federal Reserve has argued that, "a single regulator would be more likely to make sudden and, perhaps, dramatic changes in policy that would add uncertainties and instability to the banking system." (11) Others would argue, however, that innovation is driven by the marketplace, not by the regulators. Regulators mostly react to the events that drive the regulated institutions and are kept in check by congressional oversight, the courts, the press, and market pressures. (12)

IV. THE CHANGING FINANCIAL MARKETPLACE

It was recently reported that deposits as a percentage of assets in banks have fallen to their lowest level since the FDIC was created in 1933. (13) This is but one aspect of the dramatic shift in the choices faced by bank customers over the past 70 yr. In 1945, deposits and bank capital funded almost all bank activity (Figure 1). Moreover, deposits consisted primarily of demand deposits that not only paid no interest but also often cost consumers who used them a fee. Over time, the use of demand deposits declined. Although some of the decline was offset by growth in savings and time deposits (including the use of NOW accounts as a substitute for demand deposits), the overall result was a slow but steady decline in deposits as a funding source for banks until the 1990s when this trend accelerated. By the end of 2005, total deposits accounted for slightly more than 60% of bank liabilities.

[FIGURE 1 OMITTED]

Following World War II, consumers began to rebalance their financial portfolios--increasing their direct holdings of corporate equities and insurance and pension products while slightly decreasing their reliance on bank deposits (Figure 2). Following a downturn in the stock market in the late 1960s, however, direct holdings of corporate equities declined and the holdings of deposit instruments grew. From the mid-1970s through the early 1980s, deposit instruments represented the largest category of household financial assets. The proportion of financial assets in pension funds, however, continued to grow as corporations shifted from "defined benefit" to "defined contribution" pensions, leaving consumers in charge of investing their own retirement funds. (14)

[FIGURE 2 OMITTED]

Increasing rates of inflation in the late 1970s spurred the development of competing products for household deposits, and by the mid-1980s, disintermediation once again took hold. (15) Money market mutual funds grew, albeit accounting for only a small proportion of household financial assets. Mutual funds, too, gained as the stock market once again began to advance and consumers sought the advantages of professional money management. The largest growth, however, took place in pension fund reserves. By 1985, pension fund reserves represented 30% of household's financial assets.