The post office’s recent announcement that it was entering the banking business 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, about 3,000 federally insured financial institutions failed; 1,600 of them were banks. The Dow Jones Industrial Average had nearly tripled, short-term interest rates topped 12%, inflation hit double digits, and the price of oil collapsed from a high of $111 to $26 a barrel. But perhaps most disruptive was the shifting ground under bankers’ feet created by competition from the increasing popularity of mutual and money market funds.
Those funds attracted huge amounts of what otherwise would have been insured bank deposits. That was because money market funds were not banks and were not subject to Regulation Q, which limited banks and savings institutions to paying 5.5% on deposits. Consumers naturally flocked to an instrument that was able to pay 12% or more. As a result, the money market fund industry doubled in size in those years, growing from $66 billion to $122 billion, causing massive disintermediation and liquidity crises at banks at a time when the economy was already quite challenging.
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 bickered over brokered deposits, the regulation of funds, bank capital, the chartering of new banks and when and how to close failing institutions. Some of those 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 William M. Isaac, former chairman of the FDIC, and I explained in our
The role of money market funds today is being played by technology companies. Armed with great new financial ideas, products and delivery channels, fintechs are rapidly realigning the competitive dynamics in financial markets. Most of these new players are not prudentially regulated and naturally want to avoid such oversight while enjoying the benefits of operating in the financial services market. Banks are beginning to remember what it was like to be disintermediated from their customers in the 1980s.
A new breed of competitor is emerging at every edge of the banking business. Cryptocurrencies and stablecoins of all sizes and shapes have gained a remarkable level of acceptability, reaching $2 trillion in value notwithstanding that they aren’t generally used as money, and many have no intrinsic value or government safety nets 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 make loans. Crypto exchanges are acquiring trust charters and a range of fintech companies are seeking to acquire bank charters. If that is to the benefit of consumers, that process is a good one. Yet, more than a decade into this experiment, neither Congress nor the regulators have come to a consensus about whether or how they should be regulated.
And then there is the government itself trying to compete with banks. The Federal Reserve is evaluating the benefits of issuing a central bank digital currency, a product that by the Fed's own admission is fraught with security challenges and could significantly dislodge banks from their roles as financial intermediaries.
Finally, the post office has just begun to offer paycheck-cashing services at several East Coast locations. 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 on many levels, but particularly given the post office’s financial history and recent performance relative to the need in the banking business for stability and durability.
It is not the role of the government to prevent or redirect progress, and it should not be competing with the market if the market can fill the financial needs of the public. And it is not in the public interest for federal and state regulators to once again be squabbling over jurisdiction and facing each other in courts duking it out over the right to regulate and collect assessments from new tech players.
Government’s job is to ensure a safe environment for the private sector to experiment with financial evolution, and then adapt the regulation needed to maintain a safe and sound financial system. That did not happen in the 1980s, and we paid the price then and again in 2008. We will pay the price yet again if the obsolete regulatory structure in place today is not modernized to match the changes in the market being forged by new technologies.
As to 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 be bank-centric. Today, banks control less than 40% of total deposits and assets under management, suggesting that in rough terms, the government now devotes 100% of its prudential regulatory resources to oversee less than 40% of the financial services market. As we saw in 2008, such a lopsided regulatory approach encourages high levels of financial risk to gravitate toward the unregulated parts of the market, building the potential for systemic risk to hide in plain sight.
Technology is today’s squealing siren warning us that it is time to modernize the financial regulatory structure. Effective financial regulation should be applied functionally based on the financial activities a company engages in rather than whether it is a bank. There must be a level regulatory playing field between banks and every other company that wants a piece of their action. Similarly, financial regulation must incorporate Big Data techniques, artificial intelligence and sophisticated algorithms to function on a real-time basis. Regulation must be more predictive and less reactive. Finally, the regulatory system must be streamlined, consolidating agencies to achieve greater efficiency and effectiveness.
The goal of regulation is not to limit progress. It should be neutral toward technology except to the extent that it needs to adapt as markets change to ensure equal advantages for and obligations on those that impact the security and stability of the economy. Keeping the regulatory apparatus up to date is one of the best ways of avoiding financial crises, something that the U.S. has not been very good at doing in the last 200 years.
