On this day in economic and financial history …
President Carter signed the Depository Institutions Deregulation and Monetary Control Act of 1980 — the DIDMCA — into law on March 31, 1980. Now widely recognized as landmark legislation — perhaps the single most important legislative change to banking-sector regulations since the New Deal — the DIDMCA’s ultimate impact could not have been known at the time. Here’s a list of some of the DIDMCA’s key provisions. See if you can spot the ones that would have the greatest impact on America’s financial system.
All depository institutions (banks, thrifts, savings and loans, and credit unions) were required to report to the Federal Reserve — previously, only about a third of U.S. banks did so.
All depository institutions were required to maintain reserves of at least 3% for smaller transaction amounts, and up to 14% for larger cumulative transactions (over $25 million).
Federal Reserve member institutions would have eight years to amass the reserve levels required under the new law (four years for member institutions joining later).
Any financial institution that deals only with other institutions (bankers’ banks, so to speak) would be exempt from reserve requirements.
Interest-rate ceilings on deposits would be eliminated.
Checking accounts would be eligible to receive interest on their deposits.
The functions of savings and loans were expanded to be roughly equal to those of traditional banks, which included making loans, investing in money market funds, issuing credit cards, and the like.
Federal deposit insurance was raised from $40,000 to $100,000 per account.
State usury restrictions on interest charged for bank loans were eliminated, and interest was pegged at a level set a certain amount over the Fed’s discount rate.
Lending processes were simplified.
Changes to interest-rate ceilings had a notable effect on the American financial industry. The late ’70s had seen a stagflationary economic environment raise both inflation and real interest rates far beyond the interest ceilings then in place. This scenario caused a credit crunch, as depositors sought out market rates of return on their finances, often moving money from savings accounts to investment vehicles. However, other changes combined with the removal of interest ceilings to create problems for later administrations.
The increase in deposit insurance helped create a greater level of risk and moral hazard in the financial system when combined with looser lending restrictions and higher interest rates on deposits. Reassured savers added money to higher-yielding accounts — particularly those offered by thrifts and savings and loans — and these deposits swelled the reserves of financial institutions, allowing greater levels of lending. More than 500 new savings and loans were chartered from 1980 to 1986. The removal of interest-rate caps on loan offerings also gave institutions the incentive to provide mortgages and other financial products to riskier borrowers.
You’ll recognize these elements as familiar causes of a more recent financial crash, but it wouldn’t take long for the effects of risky lending and looser interest rates to cause problems in the 1980s. Within a decade of the DIDMCA’s passage, the savings and loan industry was in a full-blown crisis, one that required more than $100 billion in bailouts from the federal government.
However, a greater level of federal oversight and insurance undoubtedly helped swell the holdings of the financial system, which in turn contributed to the enormous wealth expansion of the 1980s and 1990s, as larger reserves were used to finance businesses and homeowners across the country. The Dow Jones Industrial Average didn’t bottom out for another two years — but once the revamped financial system began to act, stocks were off to the races. The Dow’s rise from 1982 to 2000 was by far the greatest period of growth in its history, roughly three times as large (in either nominal or real terms) as even the remarkable gains of the Roaring ’20s. The DIDMCA was not solely responsible for this growth — nor was it the sole cause of the later financial crises — but its impact on the American financial system is simply too important to overlook.