December 11, 2007 

(Just Like) Starting Over. 

Do you remember 1980?  John Lennon had come out of “retirement” to record the “Double Fantasy” album (yes, we called them albums in those days) including its hit single “(Just Like) Starting Over”.  Ronald Reagan was just a former governor of California.  I was a sophomore at J.I. Case High School in Racine, Wisconsin.  Also, in the spring of 1980 Congress passed “Depository Institutions Deregulation and Monetary Control Act.”

DIDMCA, as it is known, was an attempt by Congress to “do something” about the problems the U.S. banking system was facing.  Back in those days commercial banks were limited on the types of accounts they could offer. 

In addition, banks and savings & loans where hampered by interest rate ceilings that dated back to the Great Depression of the 1930’s.  These interest rate ceilings, called Regulation Q, had resulted in banks, S&Ls, and other depository institutions loosing huge amounts of their deposits to accounts offered by money market mutual funds, which were not subject to Regulation Q.

Congress in an attempt to address the “disintermediation” (the term economists use for funds going from one financial institution to another) decided to phase out Regulation Q with DIDMCA.  Sounds good right?  Why not “deregulate” the banking system and make it more competitive?

The problem is:  there is a big difference between addressing the symptom of a problem and addressing the cause of a problem.  DIDMCA addressed disintermediation, which was a symptom of a bigger problem in the banking system:  it had major structural problems that needed to be corrected, and making things worse the majority of the remaining regulations were designed for the world of the 1930’s.

DIDMCA did not solve “the problem” it merely led to even bigger problems:  the Savings & Loan crisis of the 1980s, the third world debt crisis, and the banking crisis of the 1990s. 

So here we go again…the banking system is having another “crisis” and it appears that the political leadership in Washington wants to “do something” about it.  To borrow a phrase from John Lennon, it is (just like) starting over.  But will we make the same mistakes again?

The talk in Washington these days is that “something” must be done about the increasing number of home foreclosures and the spreading subprime mortgage crisis.  It certainly did look like a “crisis” this August when banks refused to lend to one another due to uncertainty over who had how much exposure to subprime mortgages.  The Fed Funds market was impaired as was the commercial paper market.

So great is the concern today that we have not seen the bottom of the crisis that the Fed is continuously cutting interest rates.  Not be left out, Congress and the Administration are debating about the best way to freeze interest rates on adjustable rate subprime mortgages, and what to do about the commercial paper market.

But…the haunting question is:  are we, once again, only addressing the symptoms of the problem without addressing the causes of the problem?

The causes of the problem are many and they are deep.  They include the lack of savings and high debt levels of the American consumer.  They include the misaligned incentives in financial markets.  They include the moral hazard of past bailouts.  They also include the distortions in financial markets caused by the tax incentives and tax breaks.  But, it seems no one wants to talk about these deeper structural problems.

It sure feels (just like) starting over…again.  Is this 1980 all over again?

Regards,

M. Brandl