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Fede 0 MAY 1 For years, banks were among the most heavily regulated institutions in America . Recently, however, deregulation has progressed at such a rapid pace that the public sometimes has difficulty keeping abreast of the changes . All too often, the person who reads an article about a loophole in the Bank Holding Company Act and then hears a news report about some new challenge to Glass-Steagall might not recall the major provisions of either act. The following article describes several important pieces of federal banking legislation, starting with the National Currency Act of 1863 and ending with the Garn-St Germain Act of 1982. The descriptions are brief since the article is intended to serve as a simple reference guide for the reader who is struggling to keep up with the potentially bewildering changes in federal banking regulations. NATIONAL CURRENCY ACT OF 1863/NATIONAL BANK ACT OF 1864 The early years of the American Civil War did not go well for President Lincoln . Incompetence, battlefield reversals, and graft put a severe financial strain on the federal government. Faced with the need to borrow huge amounts of money, Mr. Lincoln's Secretary of the Treasury, Salmon P. Chase, looked for a way to shore-up the market for U.S. government bonds. With Chase's backing, Congress passed the National Currency Act of 1863 and the National Bank Act of 1864. Prior to the passage of these acts, banks were chartered under state laws and were subject only to state Tough Acts to Follow Courtesy of the Woodrow Wilson Birthplace Foundation President Woodrow Wilson signed the Federal Reserve Act on December 23, 1913. control. State-chartered banks issued their own notes in a bewildering variety of sizes, denominations, and designs. The soundness of these notes varied according to the soundness of the issuing bank. (Checking accounts were rare before the Civil War. For the most part, banks made loans by issuing bank notes to the borrower. When spent, the bank notes bec am e part of the circulating medium of exchange.) The National Currency Act of 1863 and the National Bank Act of 1864 created a homogeneous national currency and established a national bank system that gave the federal government greater control over banking. Under the new laws, banks were allowed to incorf orate under or convert to a federa charter rather than a state charter, and the Office of the Comptroller of the Currency was created to supervise national banks. Federal Reserve Bank of Boston https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis A national bank was required to buy bonds of the United States government in amounts equal to one-third (later one-fourth) the dollar value of the bank's capital stock. In return, only national banks were allowed to issue national bank notes . Subsequent legislation, passed in 1865, levied a tax of 10 percent on notes circulated by state-chartered banks, thereby tending to tax state bank notes out of existence. FEDERAL RESERVE ACT (1913) The financial panics of 1873, 1893, and 1907 pointed up weaknesses in the American banking system. In each instance the pattern was roughly the same . A major business failure caused the public to become apprehensive about the country's economic future. Anxious depositors then rushed to convert bank deposits to cash. The Vol. 10 , No . 2 - June 1984 beleaguered banks, in turn, tried to withdraw whatever reserves they held in correspondent banks and thus put increased pressure on the large money center banks. Sometimes the need to raise cash would force several harried banks to sell their securities at the same time, and the resulting glut would force a disastrous drop in securities prices. Or perhaps a "run" might force a bank to call in its loans and thereby force its commercial customers into insolvency. The Panic of 1907, in particular, underscored the need for a central institution which would hold the reserves of commercial banks and have the authority to increase the reserves through its own credit-granting powers. On December 13, 1913, President Woodrow Wilson signed the Federal Reserve Act. The Act provided for "the establishment of Federal Reserve banks to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes." Under these provisions, the United States was divided into twelve Federal Reserve Districts, each with its own Federal Reserve Bank. Each Reserve Bank was to be run by a nine-member Board of Directors, and the entire Federal Reserve System was to be presided over by a seven-member Federal Reserve Board in Washington, D.C. (Until 1935, the Secretary of the Treasury and the Comptroller of the Currency were ex officio members of the Federal Reserve Board.) All national banks were required to become members of the Federal Reserve System; state banks were allowed to become members if they complied with certain federal requirements . A member bank was required to deposit reserves with its District Reserve Bank. (District Reserve Banks had the power to extend credit to a member bank; they could, in effect, add to a member bank's reserves if the need arose.) In return for holding reserves, member banks were allowed free access to a variety of services, including the Federal Reserve System's check clearing network. This brought order and increased efficiency to the nation's payments system. page 2 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Courtesy of West Glen Communications McFADDEN ACT (1927) The McFadden Act is often cited as one of the major legal obstacles to interstate banking. Originally, however, the Act was intended to allow national banks more latitude to compete against state-chartered banks . In 1909, California became the first state to permit state-wide bank branching . Several other states soon followed suit, and by 1915 the number of branches operated by state-chartered commercial banks had jumped to 759 (up from 119 in the year 1900). The National Currency Act of 1863 and the National Bank Act of 1864 had made no provisions for bank branching, so nationallychartered banks were left at a competitive disadvantage. In an effort to give national banks similar branching powers to those enjoyed by state-chartered banks, Congress passed the McFadden Act of 1927. The Act allowed national banks to engage in city-wide branching. Each national bank in a city with a population of 25,000 to 50,000 would be permitted one branch in that city; in cities with a population of 50,000 to 100,000 each national bank would be permitted two branches within city limits; and in cities with more than 100,000 inhabitants, each national bank would be permitted as many branches within city limits as the Comptroller of the Currency would approve. Despite passage of the McFadden Act, state-chartered banks continued to enjoy a competitive advantage over national banks because many states permitted statechartered banks to engage in statewide branching. In 1933, however, Congress amended the McFadden Act to allow national banks identical branching powers to those of state-chartered banks. This change, in effect, established state boundaries as the limits for branching and conceded to state legislative bodies the power to determine how widely banks could branch within each state. At the present time Oune 1984), the McFadden Act is being tested by the fact that various states permit interstate banking under different conditions. Maine, for example, allows entry to a banking organization from any state, whereas Massachusetts and Connecticut laws permit entry only from New England states with similar laws. Such regional compacts, however, foster only a limited form of interstate banking. As currently proposed, these compacts effectively exclude the largest money center banks. In some cases, therefore, money center banks have filed suit to have regional banking compacts nullified. This, in turn, creates a great deal of uncertainty for banks that have already crossed state lines on the basis of a regional compact. EMERGENCY BANKING ACT/ BANKING ACT OF 1933 BANKING ACT OF 1935 The early 1930s were a time of deep crisis for the American banking system. Some 4,000 banks failed in 1933 alone. Public confidence in banking hit rock bottom. From some quarters arose a cry for the nationalization of banks. The situation called for decisive action. On March 4, 1933, President Franklin Roosevelt declared a nationwide bank holiday and then summoned Congress into special session. The bank holiday closed all banks "in order to prevent the export, hoarding or earmarking of gold and silver coin or bullion or currency." This action put a temporary stop to bank "runs" and gave Congress a few days to devise a plan for saving the American banking system. On March 9, 1933, after only a few hours of discussion, Congress passed the Emergency Banking Act. The Act gave the Secretary of the Treasury power to prevent gold hoarding and to take over gold bullion and currency in exchange for paper. It also provided for tne review, certification, and reopening of the nation' s banks. When banks that were certified as sound began to reopen on March 13, deposits far exceeded w ithdrawals . The Emergency Banking Act had bolstered public confidence. Just a little more than three months later, on June 16, Congress passed the Banking Act of 1933 (also referre d to a s the Gla s sStea g all Act) . Wherea s the Emergency Banking Act included several stopga( measures , the Banking Act o 1933 made fundamental changes in the banking system . It separated commercial banking from investment banking. Commercial banks would not be allowed to underwrite securities or insurance, and investment banks would not be allowed to take deposits. The Act also chartered the Federal Deposit Insurance Corporation (FDIC) and provided for the federal guarantee of bank deposits. But the deposit insurance provision met with considerable opposition. The president Cif the American Bankers Association (ABA) vowed to fight federal deposit insurance "to the last ditch," and even President Roosevelt displayed little enthusiasm for a federal guarantee of bank deposits. Nevertheless, Congress passed the measure, and bank failures dropped from 4,000 in 1933 to 62 in 1934 (only nine of those 62 banks were insured) . Two years later, the Banking Act of 1935 changed the ~ederal Re- serve System and thereby further strengthened American banking. During the 20 years between 1913 and 1933, the District Reserve Banks, especially the Federal Reserve Bank of New York, overshadowed the Federal Reserve Board in Washington. The Banking Act of 1935, however, established the authority and relative independence of the Federal Reserve Board . (The Act also changed the Federal Reserve Board's name to the Board of Governors of the Federal Reserve Sy stem.) In order to insulate monetary policy from political pressure, the Act also provided for the removal of the Secretary of the Treasury and the Comptroller of the Currency as ex officio members of the Board of Governors. Furthermore, the Banking Act of 1935 gave the Federal Open Market Committee (FOMC) wider authority to affect bank reserves through the open market purchase and sale of U.S . government securities. (The FOMC is the monetary policymaking body of the Federal Reserve System. It is composed of the seven members of the Board of Governors and five Reserve Bank presidents, four of whom serve on a rotating basis.) BANK HOLDING COMPANY ACT OF 1956 A bank holding company is a company that owns or otherwise controls one or more banks (i .e. , one-bank holding companies and multi-bank holding companies) . Prior to 1956, holding companies could and did acquire banks in different states, thereby skirting state and federal regulations against interstate banking. Such holding companies sometimes also engaged in nonbanking activities /;', I. ~t~-tl' -nud,! $3 state bank note, Bank of Michigan, Marshall, Ml. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis under the Banking Act of 1933 (Glass-Steagall). Concern over the proliferation and unregulated growth of bank holding companies prompted Congress to pass the Bank Holding Company Act of 1956. The Act required that bank holding companies secure approval of the Board of Governors of the Federal Reserve System prior to acquiring 25 percent or more of the stock of additional banks. Section 3(d) of the Act, better known as the Douglas Amendment, prohibited multibank holding companies from acquiring a bank in another state unless that state's law specifically authorized such acquisitions. In addition, the Board of Governors was given approval power over the formation of new bank holding companies. Furthermore, the Act barred bank holding companies from engaging in nonbanking businesses. In 1970, Congress amended the Bank Holding Comrany Act to: 1) expand the ·Federa Reserve's authority over one-bank holding companies, and 2) expand the Federal Reserve's authority to determine which "nonbank" but "bank-related" activities a bank holding company would be allowed to pursue . DEPOSITORY INSTITUTIONS DEREGULATION AND MONETARY CONTROL ACT OF 1980 Prior to passage of the Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDAMCA), member banks of the Federal Reserve System (all national banks and some state-chartered banks) were subject to reserve re- quirements set by the Board of Governors of the Federal Reserve System. By the same token, only member banks were allowed direct access to Federal Reserve discount and borrowing privileges as well as free use of such Federal Reserve services as check processing and electronic funds transfer. During the 1970s, interest rates began to rise sharply. Many national banks switched to state charters and withdrew from the Federal Reserve System in order to avoid the System's reserve requirements. page 3 In an effort to reverse this trend, Congress passed the Depository Institutions Deregulation and Monetary Control Act of 1980. The Act extended reserve and reporting requirements to all depository institutions, regardless of Federal Reserve membership. In addition, any depository institution would be entitled to the same Federal Reserve borrowing privileges as member banks, and all depository institutions would be allowed access to Federal Reserve services. The services, however, would be priced, and even member banks would pay to use them . Among other things, the Act also provided for: 1) an orderly phaseout and ultimate elimination of interest rate ceilings, 2) N .O .W . accounts nationwide, and 3) an increase in federal deposit insurance from $40,000 to $100,000. GARN-ST GERMAIN ACT (1982) From the 1930s until the 1970s, thrift institutions (savings and loan associations, mutual savings banks, and credit unions) benefitted from federal regulations that kept a ceiling on interest rates and limited the types of deposit instruments offered to savers. The thrifts took small, short-term deposits in order to make larger, longer-term loans. This practice enabled millions of American consumers to purchase houses and cars by borrowing at comparatively low rates . In effect, savers subsidized borrowers. The 1970s, however, brought drastic changes. Accelerating inflation, rising interest rates, and the increasing cost of attracting deposits put the squeeze on thrift institutions that carried portfolios of fixed-rate, long-term assets acquired in an earlier period at low rates. Furthermore, the thrifts' traditional source of low-cost funds dried up, as small savers moved their money into such nonbank financial instruments as money market mutual funds. (Money market mutual funds offered depositors market rates of interest for a small minimum investment and no minimum maturity.) Concern over the thrift industry's plight prompted Congress to pass the Garn-St Germain Act in 1982. The Act's best known provision authorized depository institutions to offer an account "directly equivalent to and competitive with money market mutual funds ." This account would pay market rates of page 4 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis interest on a minimum balance of $2,500 (no minimum maturity). In addition, the account would offer limited transaction features (six transfers per month, no more than three by check), and deposits would be protected by federal deposit insurance. The Act also provided for a Super N.0.W. Account (unlimited transaction features and unregulated interest rates on an average monthly minimum balance of $2,500). Finally, the Act included a number of provisions intended to allow thrift institutions and banks to compete more effectively with nonbank financial services companies . Garn-St Germain was a major step toward total deregulation of banking, but there now seems to be some question as to whether the trend will continue. Opponents of total deregulation point to an increasing number of bank failures, growing concern over the condition of more than one large money center bank, and uncertainty over the international debt situation. Proponents, on the other hand, claim that outmoded and unnecessary regulations keep banks from adequately responding to changing financial conditions and prevent banks from effectively competing with nonbank financial services providers. In all probability, additional banking legislation will follow Garn-St Germain. Only Congress, however, can decide what form such legislation will take. Multi-Media New Booking Procedures For Fed Films The Public Services Department of the Federal Reserve Bank of Boston makes several 16mm films available, on a free loan basis, to New England schools and organizations. As of September 1, all requests to borrow these films should be directed to: R.H.R. Filmedia 9 E. 38th Street New York, NY 10016 Requests for filmstrips, multimedia packages, games, and publications should still be sent to: Publications Public Services Department, T-3 Federal Reserve Bank of Boston Boston, MA 02106 New England Update CONNECTICUT The Greater Hartford Center for Economic Education at Central Connecticut State University and the New Britain Chamber of Commerce are working with area banks, businesses, and manufacturers on a program called the Central Connecticut Teachers in Business and Industry Program. One major purpose of the program is "to promote a fuller understanding among teachers and their students of how the operations of business and industry affect their lives and contribute to the economic and social well-being of their community ." For additional information please write to the Center for Economic Education, Marcus White Hall, Room 103, Central Connecticut State University, New Britain, CT 06050; or phone (203) 827-7318. MAINE The Maine Council on Economic Education will conduct two teacher workshops this summer. The first workshop will be held at the University of Maine (Orono) from June 18 - July 6, and the second will be held at the University of Southern Maine (Portland) from July 8 - July 13. For details please contact: Robert Mitchell, Executive Director, Maine Council on Economic Education, 22 Coburn Hall, University of Maine, Orono, ME 04469; phone (207) 581-1467. theLEDGER Editor: Robert Jabaily Graphics Arts Designer: Ernie Norville Photography: Wilson Snow Johannah Miller This newsletter is published periodically as a public service by the Federal Reserve Bank of Boston. The reporting of news about economic education programs and materials should not be construed as a specific endorsement by the Bank. Further, the material contained herein does not necessarily reflect the views of the Federal Reserve Bank of Boston or the Board of Governors. Copies of this newsletter and a catalogue of other educational materials and research publications may be obtained free of charge by writing: Bank and Public Information Center, Federal Reserve Bank of Boston, Boston, MA 02106, or by calling: (617) 973-3459.
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