Fall 1983 – Issue 30 - Stanford Lawyer - Stanford University

The Impact of InflationThis brings me to the issue of howthe nature of competition in thefinancial services industry has beenaltered in the past few years, andhow that will also shape the future.The moving force in redrawing thecompetitive picture in banking hasbeen the high and variable rate of inflationexperienced in the 1970s,with resulting wide fluctuations ininterest rates. lIigh interest rateshave had one set of consequences,and rapid fluctuations have hadanother, so they should be keptdistinct.Several periods of high interestrates have now largely destroyed theRegulation Q era of controlled depositmarkets. When, in a time of risingmarket rates, ceilings move littleor not at all, enormous costs are imposedon depositors, and large incentivesexist to find ways aroundthe restriction, while the response ofregulators is of necessity cumbersomeand laggard. Sooner or laterthe horse will leave the barn, andthen locking the door will becomeirrelevant. Familiar examples are affordedby NOW accounts and moneymarket funds: the not inconsiderableexpenses required to create them arejustified only by the reduction in thecosts of Reg Qborne by depositors.Even if the recent decline ininterest rates is permanent (anoptimistic assumption), Reg Q willmost probably not be restored to itsformer tarnished glory. Competinginstitutions have now come into existence,and they constitute a powerfilllobby against extension of thebuyers' cartel that Reg Qrepresents.Consumer attitudes have changed,because consumers have been educatedabout the cost of deposit ceilingsand learned alternative ways oftransacting. The fighting beforeCongress over the 1980 and 1982depository institutions acts was onlya struggle over the pace of the inevitable.There will be essentially afree market rate paid for most depositfunds well before the formaldate of 1986, as the DepositoryInstitutions Deregulation Committee(DIDC) actions of December 6,1982, have now made clear.The spreading competition forfunds has also added to the pressureagainst geographic market barriers.On the investment and lending side,those barriers have been mostly ineffectualfor some time, at least atthe wholesale or commercial customerlevel. Loan production offices,correspondent or syndication relationships,and servicing arrangementshave all been used to getaround the law's hostility to portfoliodiversification and the flow of fundsto their most productive uses. It is onthe deposit liability side and at theretail level that the barriers remain areal impediment to competition. TheMcFadden Act, the Douglas amendmentto the Bank lIolding CompanyAct, and the Savings and Loan lIoldingCompany Act prevent unfetteredinterstate branch competition bybanks and S&Ls, but other institutionsand other forms of competitiondo cross state lines. The fact that nostatute prohibits federal S&Ls frombranching or merging across statelines is another potential advantage,so far only partially realized, for thesavings and loan industry.As competition for deposit fundshas led non-banks, such as MerrillLynch, to break into banking markets,product-line barriers have alsocome under pressure- in particillar,the distinction between banking andthe securities business. The bankingindustry has made several unsuccessfultries to get a partial repeal ofthe Glass-Steagall Act, so that bankscould offer mutual funds and underwritemunicipal revenue bonds;surely, the effort will be renewed.Even more important, the limitationof bank holding companies to"closely related" activities, as so farrather narrowly defined by theFederal Reserve Board, is likely toreceive more attention soon.The rapid interest-rate fluctuationsof the 1970s have had their ownconsequences, making painfully apparentthe dangers of a long-termasset structure when combined withshort-term liabilities. The problemsof the savings and loan business havenot gone unnoticed by the public,although federal deposit insurancehas forestalled any real crisis ofconfidence. But I suspect there arenow relatively few supporters-ingovernment, academia, or even inS&L management- for the continuationof a set of institutions mandatedby law to make fixed-rateinvestments on the basis of withdrawableaccounts.The Thrift IndustryTodayWhere do all these developmentsleave the traditional thrift industry inthe 1980s? I do not pretend to muchcertainty in answering that question,but I will at least try to work out theramifications of one line of analysis.lIistorically, the savings and loanbusiness has been based on performingtwo functions - making real estatemortgage loans, and servicingsavings accounts. Nothing in thenew environment will cause thesefunctions to disappear, because bothare needed and both will continue tobe performed by some institutions,although not necessarily in the accustomedmode.Computers, communications, andcompetition do not seem likely torevolutionize real estate lending. Itisan activity that exhibits modest scaleeconomies, and one that S&Ls havealready acquired expertise in performing.In principle, there is noreason to believe that S&Ls cannotcontinue to compete successfully, sofar as the lending function itself isconcerned.What has changed in mortgagelending, of course, is that our recentexperience with volatile inflation andinterest rates has led to the creationFall 1983 Stanford Lawyer13