Banking and the New Deal

The New Deal of the 1930s era also gave rise to rules preventing banks from engaging in the securities and insurance businesses. Prior to the Depression, many banks ran into trouble because they took excessive risks in the stock market or provided loans to industrial companies in which bank directors or officers had personal investments. Determined to prevent that from happening again, Depression-era politicians enacted the Glass-Steagall Act, which prohibited the mixing of banking, securities, and insurance businesses. Such regulation grew controversial in the 1970s, however, as banks complained that they would lose customers to other financial companies unless they could offer a wider variety of financial services.

The government responded by giving banks greater freedom to offer consumers new types of financial services. Then, in late 1999, Congress enacted the Financial Services Modernization Act of 1999, which repealed the Glass-Steagall Act. The new law went beyond the considerable freedom that banks already were enjoying to offer everything from consumer banking to underwriting securities. It allowed banks , securities, and insurance firms to form financial conglomerates that could market a range of financial products including mutual funds, stocks and bonds, insurance, and automobile loans. As with laws deregulating transportation, telecommunications, and other industries, the new law was expected to generate a wave of mergers among financial institutions.

Generally, the New Deal legislation was successful, and the American banking system returned to health in the years following World War II. But it ran into difficulties again in the 1980s and 1990s -- in part because of social regulation. After the war, the government had been eager to foster home ownership, so it helped create a new banking sector -- the "savings and loan" (S&L) industry -- to concentrate on making long-term home loans, known as mortgages. Savings and loans faced one major problem: mortgages typically ran for 30 years and carried fixed interest rates, while most deposits have much shorter terms. When short-term interest rates rise above the rate on long-term mortgages, savings and loans can lose money. To protect savings and loan associations and banks against this eventuality, regulators decided to control interest rates on deposits.

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Next Article: Savings and Loan Bailouts

This article is adapted from the book "Outline of the U.S. Economy" by Conte and Carr and has been adapted with permission from the U.S. Department of State.