Financial Market Deregulation

Article excerpt

The "Economic Report of the President," prepared by the Council of Economic Advisers, was released last month. The following is the fifth chapter in the report, "Financial Market Deregulation." The council suggests that capital requirements for financial institutions by strengthened, the deposit insurance system be tied to risk, and fractional coverage be introduced for large accounts.

Over the past few years, financial markets have undergone sweeping changes of a magnitude not seen since the 1930s. Despite these changes, the process of market restructuring and regulatory reform remains incomplete. Additional regulatory changes of historic dimensions are being debated. The shape and scope of these reforms will be important to the American economy for decades to come.

The issues in financial regulation are many and complex. They include the safety and soundness of financial institutions, the problems of dealing constructively with changing technology, and the reduction of regulatory burdens to the maximum extent possible. Similar concerns are important in other industries where regulatory reform is being debated. But the financial regulatory reform issues are in many respects far larger.

Financial regulation is not simply a matter of protecting poorly informed investors -- the usual focus of consumer protection regulation -- but of protecting everyone. In the financial crises experienced in 1933 and earlier in U.S. history, well-informed, prudent investors and depositors found themselves ruined financially.

From painful experience, we know that a failure of public policy with respect to financial markets can create damage that extends far beyond the financial services industry. Financial market failure can mean economywide failure -- recession, widespread unemployment, and bankruptcies.

The essential functions of financial regulation are to ensure the safety and soundness of the financial system and to foster efficient allocation of capital by promoting competition and limiting opportunities for fraud and self-dealing.

The competitive capital markets i the United States, long encouraged by public policy, have provided highly efficient links between the providers of funds and the users of funds, directing resources into the most productive investments in the economy. But instability concern, and at times a highly disruptive fact, throughout U.S. history. The challenge for regulatory policy is to maintain stability while realizing the benefits of competition. The Major Historical Forces

It is best to begin the analysis of the key financial regulatory issues by considering the major forces that have shaped the industry and led to the present regulatory environment. These forces have included public reaction to periods of financial instability that occurred in the 1930s and earlier, public concerns over the credit powers of financial institutions and their ties with other institutions, and strong competitive pressures coming from both within and among the various segments of the industry.

Much of our inherited regulatory structure involves extensive and far-ranging legislation enacted in response to crisis. Periods of acute financial instability have resulted in the disappearance of major institutions and the introduction of new government regulations.

For example, in the 1860s, problems of Civil War finance and increasing currency disorders led the Congress to establish the national banking system and the Office of the Comptroller of the Currency. The Congress also defined the arrangements under which national banks would issue a national currency.

Later, a series of banking panics -- periods of numerous bank failures and bank suspensions of payments -- culminating with the panic of 1907, created demands for a stronger federal mechanism to prevent instability. This led to the establishment of the Federal Reserve System in 1913. …