The Financial Regulatory Regime: Hamilton's Real Legacy?
You probably haven’t ever stopped to think about the American financial regulatory structure. But, compared to most large economies, its regime is fragmented, overly complex and downright confusing. In one number in the hit Broadway show Hamilton, the show’s namesake contemplates what he’ll leave behind, asking “What is a legacy?” This week, we contemplate that legacy: the U.S. financial regulatory system as it has evolved from the nation’s first Treasury secretary.
In 1781, Hamilton said, “Most commercial nations have found it necessary to institute banks, and they have proved to be the happiest engines that ever were invented for advancing trade.” In the intervening centuries, of course, U.S. policymakers have been, at times, decidedly unhappy with banks. It’s that anger that formed the basis of the U.S. financial regulatory system. As Matthew Johnston explains at Investopedia, “The changing nature” of the U.S. financial regulatory system throughout history “is best characterized by the swinging of a pendulum, oscillating between the two opposing poles of greater and lesser regulation.”
Or, as the Congressional Research Service (CRS) more dryly explains, “financial regulation in the United States has coevolved with a changing financial system, in which major changes are made in response to crises” and where powers are sometimes “trimmed back during financial booms.”
The origins of our financial regulatory system start at our nation’s inception. Hamilton developed a plan for a federal banking system that would help solve the nation’s credit problems after the Revolutionary War. Though commercial and financial interests in the northeast supported Hamilton’s plan, he faced a fierce foe in the form of Secretary of State Thomas Jefferson who preferred a less central system and who argued Hamilton’s outline was unconstitutional.
Hamilton won that ideological struggle, and First Bank of the United States was chartered in 1791. His system was short-lived, however, and a bill to re-charter the bank failed 20 years later. A second central bank lasted from 1816 until President Andrew Jackson declared it unconstitutional in 1836. As a result, the period between the mid-1830s and the Civil War is known as the “free banking era,” and it was, as described by the San Francisco Federal Reserve, marked by “a hodgepodge of state-chartered banks not subject to federal regulation.” There were almost 8,000 state banks across America by 1860 and every single one issued its own paper notes.
The result of these fits and starts, the CRS says, is a “fragmented” and “piecemeal” system “with multiple overlapping regulators” at both the state and federal levels, including depository regulators.
The Office of the Comptroller of the Currency is the oldest of the federal depository regulators. It was established by President Abraham Lincoln who, like the first U.S. Treasury secretary, favored a strong national banking system and also spent a lot of time thinking about his legacy, though under markedly different circumstances. According to the OCC, President Lincoln and his Treasury Secretary “recognized that unreliable paper money and inadequate credit was problematic” and so “conceived the national banking system and the Office of the Comptroller of the Currency to regulate and supervise it.”
The National Currency Act, signed by President Lincoln on Feb. 25, 1863, tasked the OCC with “organizing and administering a system of nationally chartered banks and a uniform national currency.”
Though that law has been amended over the years – including in 1864 to generate funding for the Civil War – it still provides the basic governing framework for the national banking system today.
Instituted in 1913, the Federal Reserve also developed in response to national turbulence. The nation’s first 120 years were marked by multiple bank failures and outright financial panics. More than 500 banks failed in the panic of 1893. It was the panic of 1907, though, that “galvanized a movement for federal banking reform” and that led to the creation of the Federal Reserve.
Congress has strengthened the Fed several times over the last century. The Banking Act of 1935 established the Federal Open Market Committee and the Federal Reserve Reform Act of 1977 explicitly set price stability as the Fed’s policy goal for the first time. The Full Employment and Balanced Growth Act of 1978 set full employment as a second goal. These “dual mandates” govern the Fed’s monetary policy today.
The financial panics of the late 19th and early 20th century also generated calls for a system of federal deposit insurance. In fact, between 1886 and 1933 there were at least 150 calls in Congress for federal deposit insurance. Up until 1933 only a handful of states – Kansas, Mississippi, Nebraska, North Dakota, Oklahoma, South Dakota, Texas, and Washington – insured deposits, but these states were overwhelmed by the events of the Great Depression.
So the Federal Deposit Insurance Corporation came into being in June 1933 with the Banking Act of that year. Almost 5,000 banks had failed in the years between 1930 and 1932. Nearly 4,000 banks would do so in 1933, and the cumulative cost to depositors during that time was $1.3 billion – a staggering sum.
The FDIC was meant to be a temporary agency, but, thanks in large part to its efforts, only nine banks failed in the year after the Banking Act was signed. Based on its early record of success, Congress made the FDIC a permanent agency with the Banking Act of 1935.
Another product of the Great Depression was the Federal Credit Union Act of 1934, which allowed chartered federal credit unions in the U.S. states. After 36 years and significant growth in the number of credit unions across the country, Congress passed legislation creating the National Credit Union Administration (NCUA).
While not every regulatory agency was borne out of crisis (and the NCUA certainly is one example), the Consumer Financial Protection Bureau was. As the bureau tells it, in the wake of the 2007 financial crisis, the nation needed a body “focus[ed] directly on consumers, rather than on bank safety and soundness or on monetary policy.” The CFPB was meant to consolidate “in one place responsibilities that had been scattered across government”; supervise and enforce “with respect to the laws over providers of consumer financial products and services that escaped regular federal oversight”; and “protect families from unfair, deceptive, and abusive financial practices.”
And so, another federal regulatory agency was added to the alphabet soup of cops on the financial beat. While Hamilton clearly favored a strong federal system, even he would be surprised by the fragmentation that arose in the centuries after his time.