Kenneth R. Szulczyk
Why did U.S. and state government propagate such a complex system? Financial sector is
an extremely important sector of the economy, and every country around the world regulates its
financial markets. Government uses six reasons to regulate a banking system and its financial
markets, which include:
Reason 1: Governments want the financial system to be stable. Banks contribute to a
nation’s money supply. A wave of bank failures could trigger a large contraction in the money
supply, shrinking the economy and triggering a severe recession. Many economists believe the
Great Depression would not be severe if a wave of bank failures had not swept across the
country.
Reason 2: Money supply and financial markets are intertwined. If the central bank uses the
money supply to influence the inflation, business cycle, or interest rates, the central bank also
affects the financial markets. Consequently, central banks need government regulations to
control monetary policy effectively and help achieve low inflation and low unemployment.
Reason 3: The U. S. government wants to promote efficiency in the financial
intermediation process.
Reason 4: The U.S. government wants to provide low-cost financing for homebuyers. This
desire led to the U.S. Housing Bubble that occurred between 1997 and 2007.
Reason 5: Financial markets depend on accurate information. Governments ensure
borrowers provide accurate information to investors. In the United States, the Securities and
Exchange Commission (SEC) requires publicly traded companies (i.e. a company sells stock to
the public) to disclose financial information based on acceptable accounting standards.
Reason 6: The U.S. government wants to protect consumers. Financial system, such as a
bank can be very complicated. Many depositors do not understand the financial instruments, and
therefore, they are not able to gauge the soundness of the institution or make rational decisions.
In a competitive market like TVs, DVDs, computers, and cell phones, the consumers can easily
evaluate and compare different products.
The Glass Steagall Banking Act
Politicians and the public thought commercial banks should not underwrite new stock and
bonds for corporations because they believed banks were underwriting “risky” securities.
Furthermore, the banks possess enormous power to create monopolies. Thus, the United States
government passed the Glass-Steagall Banking Act in 1933. This law divided the functions of
investment banking and commercial banking. A commercial bank is a standard bank while an
investment banker markets and sells brand new stocks and bonds. In practice, the Glass-Steagall
Banking Act insulated investment banking from the competition. Consequently, borrowers
could pay more for issuing new securities than they would pay if commercial banks could
underwrite new securities. The United States government repealed pieces of the Glass-Steagall
Act in 1999 to allow U.S. investment banks to compete internationally as they moved into
commercial banking and insurance.
The Glass-Steagall Act also created the Federal Deposit Insurance Corporation (FDIC). The
FDIC, a public corporation, insures the deposits of each depositor in commercial banks up to
$250,000. For example, if you have $150,000 in your checking account and $150,000 in