The recent announcement by post of its entry into the banking industry is a stark reminder of how we seem to have forgotten the causes of the second worst economic decade in the country’s history – the 1980s. Forty years later, we are about to recreate the events that caused it.
In the 1980s and early 1990s, approximately 3,000 federally insured financial institutions went bankrupt; 1,600 of them were banks. The Dow Jones Industrial Average nearly tripled, short-term interest rates exceeded 12%, inflation hit double digits, and the price of oil plummeted from a high of $ 111 at $ 26 a barrel. But perhaps most disruptive has been the shifting ground under the feet of bankers created by competition from the growing popularity of mutual funds and the money market.
These funds attracted huge amounts of what would otherwise have been insured bank deposits. This is because money market funds were not banks and were not subject to Q regulation, which limited banks and savings institutions to paying 5.5% on deposits. Consumers naturally flocked to an instrument capable of paying 12% or more. As a result, the money market fund industry doubled in size over those years, from $ 66 billion to $ 122 billion, causing massive disintermediation and liquidity crises in banks at a time when the economy was hard enough.
At the same time, the Federal Deposit Insurance Corp., the Federal Reserve, the Securities and Exchange Commission, the Federal Home Loan Bank Board, the Office of the Comptroller of the Currency, the Treasury Department and state regulators have feuded over the about brokerage deposits, fund regulation, bank capital, chartering new banks and when and how to close failed institutions. Some of these intramural disputes actually ended up in court, causing further uncertainty in financial markets.
It feels like we are approaching a similar inflection point of competitive chaos. As the former president of the FDIC, William M. Isaac and I explained in our American banker item on July 14, 2021, there is already a substantial economic bubble fueled by government largesse, low interest rates, an inflated Fed balance sheet, excess liquidity and increasing indebtedness. And the competitive landscape is also changing again, threatening to burst this bubble.
The role of money market funds today is played by technology companies. Armed with excellent ideas, products and financial distribution channels, fintechs are rapidly realigning competitive dynamics in financial markets. Most of these new players are not prudentially regulated and naturally wish to avoid such supervision while enjoying the advantages of operating in the financial services market. Banks are starting to remember what it was like to be disintermediated from their customers in the 1980s.
A new breed of competition is emerging at every edge of the banking business. Cryptocurrencies and stablecoins of all sizes and shapes have acquired a remarkable level of acceptability, reaching a value of $ 2,000 billion, although they are generally not used as currency, and many have no intrinsic value or government safety net to fall back on when the inevitable cracks appear.
But crypto companies are now testing their ability to function as payment mechanisms, accept what banks would call deposits, and grant loans. Crypto exchanges are acquiring trust charters and a range of fintech companies are looking to acquire bank charters. If it benefits consumers, this process is good. Yet more than a decade after this experiment began, neither Congress nor regulators have reached a consensus on whether or how to regulate them.
And then there is the government itself trying to compete with the banks. The Federal Reserve is weighing the benefits of issuing a central bank digital currency, a product that by its own admission poses security concerns and could significantly dislodge banks from their role as financial intermediaries.
Finally, the post office has just started offering paycheck cashing services to several locations on the east coast. In short, the government, or in this case an entity underwritten by the government, wants to be a low cost payday lender. This is ironic in many ways, but especially given the Post’s financial history and recent performance against the banking sector’s need for stability and sustainability.
It is not the role of government to prevent or redirect progress, and it should not compete with the market if the market can meet the financial needs of the public. And it’s not in the public interest for federal and state regulators to argue over jurisdiction again and go head to head in court over the right to regulate and collect ratings from new tech players.
The job of government is to ensure a secure environment for the private sector to experience financial developments, and then to adapt the regulations necessary to maintain a safe and healthy financial system. This did not happen in the 1980s, and we paid the price again and again in 2008. We will still pay the price if the outdated regulatory structure in place today is not modernized to match developments. of the market forged by new technologies.
As for the obsolescence of the current regulatory structure, remember that when it was created between 1932 and 1940, banks controlled 95% of the financial services market. There was every reason for prudential regulation to focus on banks. Today, banks control less than 40% of total deposits and assets under management, suggesting that roughly the government is now spending 100% of its prudential regulatory resources monitoring less than 40% of the services market. financial. As we saw in 2008, such an unbalanced regulatory approach encourages high levels of financial risk to gravitate towards unregulated parts of the market, thus creating the possibility that systemic risk is lurking in plain sight.
Technology today is the howling siren warning us that it is time to modernize the financial regulatory structure. Effective financial regulation must be applied functionally on the basis of the financial activities in which a company engages rather than on the basis of whether it is a bank. There needs to be a level playing field between banks and all other businesses that want to participate in their action. Likewise, financial regulation must integrate Big Data techniques, artificial intelligence and sophisticated algorithms to operate in real time. Regulation must be more predictive and less reactive. Finally, the regulatory system needs to be streamlined, consolidating agencies to achieve greater efficiency and effectiveness.
The purpose of regulation is not to limit progress. It must be technology neutral, except to the extent that it must adapt to changing markets to ensure equal benefits and obligations to those impacting on the security and stability of the market. the economy. Keeping the regulatory apparatus up to date is one of the best ways to avoid financial crises, something the United States has not been very good at over the past 200 years.