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What is Financial Deregulation?

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  • Written By: John Lister
  • Edited By: Bronwyn Harris
  • Last Modified Date: 07 November 2016
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Financial deregulation can refer to a variety of changes in the law which allow financial institutions more freedom in how they compete. Whether such changes are beneficial or harmful to the economy as a whole has been widely debated. It is important to note that financial deregulation does not mean removing all rules or regulations.

The best known form of financial deregulation in the United States came in 1999 when Congress repealed sections of the Glass-Steagall Act. This act, passed in 1933 during the depression, meant that any one company could only act as a commercial bank, an investment bank or an insurance company. A commercial bank offered savings and loans services to customers, while an investment bank carried out functions such as selling securities, trading in foreign currencies and assisting firms in mergers.

The repeal of this act meant firms could now carry out the functions of two or all three of these types of institution. One of the main arguments in favor of repealing the act in this way was that it would limit the effects of economic cycles on individual firms. For example, people are more likely to save during a downturn, but more likely to invest when they are better off. Financial deregulation would therefore theoretically mean firms could grow in size and bring in business more consistently.

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It was also argued that deregulation would make firms more competitive. They would be able to work more efficiently, particularly where two firms from different sectors merged and pooled their resources. This could also help business as a whole because the competition and efficiency would make it cheaper for companies to obtain funding for capital investment.

Critics of financial deregulation have argued that it either caused or fuelled the banking crisis which began in 2007. They say that removing the barriers between different types of financial institutions caused conflicts of interest. For example, a company which had previously been a commercial bank, and had many consumer and business customers, might now take too many risks because it was trying to compete in the investment and insurance sectors. Critics have also argued that deregulation allowed individual financial institutions to become so big that government would have to step in when they struggled rather than let them fail and risk damaging the entire economy.

Another form of financial deregulation took place in the United Kingdom involving building societies. These are financial institutions which were owned by their customers rather than shareholders and specialised in mortgage lending. After building societies began to compete more directly with banks in the 1980s, the government changed the law to allow them to demutualize. This meant that, if the society’s members agreed in a vote, it could change into a limited company. Since that time, every building society which demutualized has either been bought out by a bank or has been taken over by the government after experiencing financial difficulties.

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sneakers41
Post 4

Mutsy - I understand blaming the banks and surely they were at fault to a degree, but I also think that a lot of people got caught up in real estate frenzy and wanted to make money fast.

Because Fannie and Freddie were backing the majority of these mortgages and they should have been heavily regulated but the irony was that congress did not want to do this.

They still offer mortgages at 3% down which really is not enough of a financial cushion in case you have to sell your home.

The Fannie Mae Home Path program was designed to allow low income families to own homes. While the idea is nice the reality is that homeownership

is risky and if you do not have enough money to put down on a home then you may struggle with the larger mortgage payment or you may even default if you have a financial setback.

The government was forcing banks to offer a percentage of their loans to low income borrowers that had little money for a down payment.

I think that this puts low income families at severe risk and the government should limit these types of loans and consider how a foreclosure or foreclosures from these type of loans destroy families and neighborhoods. Not everyone has to own a home.

mutsy
Post 3

Cupcake15 -I think that we are facing a lot of financial challenges because banks are too regulated.

Because of all of the new banking stipulations banks are not wanting to assume any risk. They have also begun to charge customers for services that used to be complimentary and some have raised their minimum payment percentages to ensure that a larger payment is made on credit cards.

There are a lot of financial challenges for banks because many have so many foreclosures to process that some have even halted the foreclosure proceedings on many homeowners because it was reported that many of the major banks were simply signing these foreclosures without notifying the homeowners properly.

I think that

banking deregulation should be in order here. I rather have the banks deciding on their lending policies than the federal government. I also think that banks should also assume the risk if they make bad decisions which is what would happen in any other business. This would make the banks more accountable.
cupcake15
Post 2

Comfyshoes - I think that banks got away from their traditional lending standards and began lending money to everyone. They even had no doc loans which were no documentation loans that allowed the borrower to state what their income with no verification needed.

There were people that were really earning $40,000 a year that were living in homes that were half a million dollars.

Some even bought additional properties even though they did not have the funds on hand or the income to afford it. Many of these subprime loans were given to people that should have never had a mortgage.

They offered interest only loans or variable rate loans that offered a lower interest rate for the

first year or so and then they began to reset.

Since most of the people buying property with these subprime loans were looking to quickly resell their properties many never thought that the bottom would fall out of the real estate market.

A lot of these people could only afford the introductory interest rates but began to struggle as the rates began to rise. Some of these people complicated things further by having two loans on the property called an 80-20 loan.

They got a first mortgage on the property for 80% and a second mortgage on the property for the other 20%. This left them with no equity and when the housing market crashed they were left with negative amortization which meant that they owed more on their home than it was worth.

I don't think that the deregulation of banks was the problem, but they should use more prudent lending standards when issuing loans.

comfyshoes
Post 1

I have to say that I think that Fannie Mae and Freddie Mac offered good programs for borrowers in theory but unfortunately there was little oversight of these institutions and this was a large reason for the financial challenges that the banks experienced because Fannie Mae was guaranteeing about 85% of all of the mortgages.

They tried to pass a bill in 2005 that forbade Fannie and Freddie from investing in mortgage securities but it failed to pass the Senate.

Over 60% of the mortgages held by Fannie and Freddie were subprime loans that held the highest levels of risk but also offered the highest possible returns.

However since the real estate market tanked and the defaults skyrocketed Fannie and Freddie needed a federal bailout just to stay afloat because they had so much financial debt.

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