Economic Report of the President

industries. Substantial and numerous innovations in the financial sectorsin the last decade largely preceded and were later facilitated byrecent partial deregulation.DEPOSITORY INSTITUTIONSThe present structure of regulatory restraints on commercial banksand other depository institutions was imposed primarily in responseto the collapse of the banking system in the 1930s. A common interpretationof the events at that time is that the banking collapse wasthe result of an unsound banking structure which caused too muchcompetition. Competition among banks was thought to force theminto paying high interest rates for deposits, which in turn led them toseek out high-yielding but risky—and ultimately unsound—investmentsin the stock, bond, and real estate markets.Legislative remedies in the Banking Acts of 1933 and 1935, andvarious revisions of the Federal Reserve Act, focused on limitingprice competition between banks, separating banking from securitiesmarket activity, supervising banking and financial markets moreclosely, and restoring public confidence in the financial system.Reflecting a general concern about excessive competition, the paymentof interest on demand deposits was prohibited by law. In addition,the Federal Reserve Board and the Federal Deposit InsuranceCorporation were given the power to place interest rate ceilings onthe passbook and time deposits of commercial banks. Interest rateceilings were extended to the deposits of mutual savings banks andsavings and loan associations in 1966.The type and quality of assets held by banks were closely monitored.Commercial banks were not permitted to hold securities of aspeculative nature in their portfolios, and thrift institutions were subjectto even greater limits on their asset acquisition powers. In addition,most securities activities were divorced from commercial bankingby the Glass-Steagall sections of the Banking Act of 1933, andentry into banking became more closely controlled. To maintain theconfidence of the public in the banking system, deposits were insuredby the Federal Deposit Insurance Corporation and the Federal Savingsand Loan Insurance Corporation. With the introduction of depositinsurance, the other regulations served mainly to limit the exposureof the insurance funds rather than to protect depositors. Nevertheless,recent studies suggest that the web of regulatory restraintswas generally greater than required for this purpose.Moreover, this extensive regulatory framework for financial institutionshas adapted slowly to the economic changes of the last two decades.High inflation rates and consequent high nominal interestrates, combined with reduced transactions costs from the application116