Banking and Credit Cards

Financial Services Information for 2020 and Beyond

Banking Overview

Banking in the United States has had its share of significant ups and downs. The central functions as an intermediary, ensuring an outlet for people to borrow money, maintain money for safekeeping or as a resource for investing funds to expand businesses hasn’t changed. Today’s technology offers a litany of products, and services can be delivered with greater efficiency. Despite numerous technological options, traditional banks remain the premier choice for savings and loans for most Americans.

At the onset of the Revolutionary War, the Continental Congress issued their own paper money. The English counterfeited the currency to devalue it, leading to massive deflation. In 1791, the first secretary of the Treasury, Alexander Hamilton, established the Bank of the United States to provide oversight to fledgling banks, create a standard currency, and raise money for the new government. The initial Congressional charter expired in 1811; a second Bank of the United States was created in 1816 and operated until 1832. Lending standards in the cities were very strict and typically short dated, capped at sixty days.. Loans were made to shopkeepers, who used the proceeds to purchase goods, repaying the loans upon the selling of the goods. In the less settled parts of the country, lending standards were significantly more liberal; losses on loans tended to be much higher. Loans were made to farmers to purchase land; inconsistent weather and crops drive losses higher.

A great idea in theory, but a disaster in reality. State-chartered banks and “free banks” issued their own notes, with no distinction between currency issued by insurance companies, restaurants or any other businesses. The 1853 creation of the New York Clearinghouse, came into existence to simplify the clearing process. (This is a precursor of today’s Automated clearing house) When the Second Bank of the United States ceased in 1832, it was up to the state’s governments to verify loans and issue convertible notes (for gold and silver). The lack of oversight and multiple forms of currency resulted in banks often holding worthless paper and insolvent. Before the start of the Civil War, it was estimated 10,000 forms of currency existed. Banking and commerce suffered; there was a need for a unified, national currency.

The National Currency Act was passed by congress in 1863, with the goal of having a national currency. President Lincoln signed a revision of the law, the National Bank Act in 1864, which established national bank charters mandating that banks hold reserves. Additionally, a Comptroller of the Currency was established to supervise the banking system. Checking accounts blossomed, as the stability of banks and unified currency provided relative safety.

The National Banking Act was a step towards modern banking, but regulation was lacking. Financial mogul J.P. Morgan twice bailed out the banking system, in 1893 and 1907 when nationwide depressions were triggered due to runs on the banks.

Despite occasional “panics” the new system with the Comptroller, mitigated damage and limited national bank failures. The national banks bought U.S. government securities, and deposited them with the Comptroller. In exchange, they received elaborately designed bank notes (meant to foil counterfeiters, and prized today for their intricate designs) which found their way into circulation. These were the first notes to feature the seal of the Treasury, and remained the core of the nation’s money supply until the onset of Federal Reserve notes in 1914.

To prevent future “panics” and maintain a healthy system, a central banking authority was required. The Federal Reserve Act of 1913 was signed into law, creating a mechanism ensuring smooth daily banking operations, including monitoring the rise and fall of inflation and deflation. Most important; ensuring appropriate levels of credit available commensurate with the economy.

The “Roaring Twenties” were a trying time for the Federal Reserve. The Fed failed to stave off a weak economy, which was met by risky investments from bank traders trying to prop up their businesses. Risky bets were made (and lost!) with public money resulting in the Crash of October 1929, which plunged the country (the world) into the greatest depression ever experienced. Thousands of U.S. banks failed, and borrowers defaulted at record rates. The subsequent customer runs to withdraw cash before bank insolvency has frequently been depicted. President Franklin D. Roosevelt established a “bank holiday” in 1933 closing all banks so for proper examination by the Office of the Comptroller of the Currency (OCC), and would be reopened only when they could meet requirements or be subjected to orderly liquidation.

In spring of 1933, Congress enacted Federal Deposit Insurance (FDIC) as part of the Glass Steagall Act. Bank accounts were insured to $2,500 per depositor ($100,000 today). The act separated commercial and investment banks to prevent previous risky investments. Finally, the act placed Open Market Operations officially under the Federal Reserve, and prohibited interstate banking. Banks regained their foothold as a safe place to deposit money.

An accord in 1951 outlined the specific roles the Fed and Treasury played. Under the Treasury Accord, the Department of Treasury is responsible for printing currency, collecting taxes and enforcing finance and tax law, and managing the government’s budget. The Federal Reserve’s role was to manage the flow of money and adjust monetary policy to maximize employment and ensure the overall soundness of the banking and financial system.

It wasn’t just disco and awful fashion in the 1970s. Banking and the economy were in disarray for most of the decade. To revive the economy and stave off inflation, President Nixon ended the gold standard in 1971, allowing the Dollar to “float” on the world market, to spur an increase in forign demand for U.S. goods. The oil embargo and Middle East war of 1973 exacerbated inflation, triggering a global recession. Unemployment eclipsed 10%; inflation 13%  by 1979. The Fed eventually brought inflation under control by using its open market operations, but the decade was lost.

The Fed’s mechanisms of the late 1970’s  helped them better navigate the economy, resulting in a significant expansion throughout the 1980s and 90s. Federal Chairman Alan Greenspan’s stance in 1987 that the Fed would serve as “a source of liquidity to support the economic and financial system,” helped lessen the Crash of 1987, and steadied the economy through the credit crunch of the early 90’s and the 1998 Russian default on government bonds.

With relatively good times at hand, in 1999 the Gramm-Leach Bliley, or Financial Services Modernization Act, was introduced,repealing parts of the Glass-Steagall Act. By combining investment and savings in one branch, an immensely stable financial institution would be created to withstand any financial conditions. The line between investment banks, commercial banks, and insurance companies was blurred. Rules were kept in place to prevent consumer money being used for risky investments, however, capital requirements for mortgages were lessened, and banks fueled a surge of questionable mortgages.

While average home prices doubled between 1998 and 2006, mortgage debt comprised 97% of the GDP.  Mortgage-Backed Securities, or Collateralized Debt Obligations (CDO’s) were a very popular bank investment vehicle because they provided lenders significant leverage which led to outside risks and packaging of the questionable mortgages.

When the real estate market crashed in 2007, CDO’s were decimated, and banks paid the price. The striking loss in value meant banks couldn’t meet their standard obligations. This resulted in the Troubled Asset Relief Program (TARP), a $700 billion bail out of the nation’s biggest banks.

Additional regulation in the form of the Dodd-Frank Wall Street Reform and Consumer Protection Act came about in 2010, establishing the Financial Stability Oversight Council to regulate bank trading and derivative products, while monitoring higher risk institutions. On the heels of banking regulation, financial technology saw a renaissance.

Online banking had been around for more than a decade, but now fintech firms could take the roles of the banks, offering traditional banking services like checking, savings, credit cards, and mortgages, offering very competitive rates. Electronic transfer of money and digital currency is becoming mainstream. Technology also governs how banks are examined and monitored, helping measure the complex risks of new derivative products and complex financial services.