When bank deregulation is dangerous if not done properly…

The usual narrative is that when you deregulate banking, crisis follows as banks take on more risks, lend/invest foolishly and so on.

Prof George Selgin says deregulation is dangerous not for the above reason but if not implemented properly:

Among last week’s news items that had colleagues asking me, “What’s your answer to this?,” was a piece by Quartz’s John Detrixhe, telling its readers that, according to “300 years of financial history,” rolling back bank regulations is a good way to trigger a financial meltdown.

Though you may be surprised to hear me say it, there’s some truth to Mr. Detrixhe’s thesis. While government intervention in banking typically does more harm than good, it’s also true that, unless it’s done carefully, deregulation can itself lead to trouble. As I put it some years ago in a Cato Journal article (reprinted recently in Money: Free and Unfree), “Dismantling bad bank regulations is like cutting wires in a time bomb: the job is risky and has to be done in carefully ordered steps, but it beats letting the thing go on ticking.”

Back in the 1980s, for example, when U.S. bank regulators phased-out depression-era regulation-Q type restrictions on the interest rates depository institutions could pay to their depositors, they unwittingly freed a moral hazard genie that those regulations had kept bottled-up for several decades.

Did that make deregulating interest rates a bad idea? It didn’t, first of all because had those rates not been deregulated banks and S&Ls would have taken a licking from new Money Market funds, and also because regulators might have avoided the moral hazard problem by allowing banks to offer competitive interest rates on uninsured deposits only. The phasing-out of reg Q and its S&L counterparts would then have proceeded only to the extent that it went hand-in-hand with deregulation of another sort, namely, more limited deposit insurance, which would have gone a long way toward avoiding the S&L crisis later that decade. (And if you think banking stability depends on deposit insurance you really do need to review some non-U.S. banking history.)


In the end he says do history but dig deeper:

although Mr. Detrixhe never actually claims that the subprime meltdown itself illustrates the supposedly general tendency for panics to follow deregulation, one suspects that he, like many others, believes this to be the case. But while many have blamed the crisis on deregulation, and especially on the partial 1999 rollback of Glass-Steagall, such claims seem to be based on little more than their authors’ preconceived notions. A close look at the evidence suggests, on the contrary, that although the crisis had many causes, deregulation wasn’t one of them.

So let’s by all means learn as much as we can from 300 years of financial history. But let’s also remember that to do so one must delve deep into that history, and not just skim the surface.

This applies in most historical analysis..


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