WSJ 5/26/18

Banks Won Big in Washington. What It Means for Investors

By Jason Zweig | 862 words

The financial-deregulation bill passed by the U.S. Congress this week is the latest phase in the eternal tug-of-war between regulators and banks. As fast as governments impose limits on the financial industry, banks, brokers and other firms fight back.

It’s been happening for millennia, and it probably will keep happening until the end of time. To invest in financial stocks, investors need to understand this cycle and where we are in it at any given point in time.

Proponents of regulation and deregulation alike tend to underestimate how soon and how far the pendulum will swoop in the opposite direction.

Governments have regulated finance since at least the Laws of Eshnunna, which set out limits and penalties in Mesopotamia more than 4,200 years ago. (The maximum allowable interest rate on loans in silver was 20%; in barley, 33.3%.)

During the reign of Emperor Tiberius (14 to 37 A.D.), the Roman usury laws, long neglected, were suddenly enforced. Compound interest and annual rates above 10% were prohibited, and loans were required to be secured by land. The result was a credit crunch and a real-estate crash, one of the first financial crises on record.

“Fraudulence, attacked by repeated legislation, was ingeniously revived after each successive counter-measure,” wrote the Roman historian Tacitus around 109 A.D. “As usual, the beginning was strict, the sequel slack.” The U.S. has followed a similar course, with banking crises in — among other years — 1819, 1826, 1837, 1839, 1857, 1873, 1884, 1890, 1893, 1907, the early 1930s, the late 1980s and, of course, 2008-2009.

It might sound odd for banks to be deregulated now, when they are reporting record profits and the highest rates of return since 2007, just before the last crisis.

In fact, that’s typical. “Regulation gets tighter after busts because people say, ‘We don’t want to have another financial crisis,’ and then it loosens during booms as the bankers complain that the rules are too stringent or just find ways around them,” says Richard Sylla, a financial historian at New York University’s Stern School of Business. “This has been going on in the U.S. since the very beginning.

”On April 10, 1792, after Wall Street’s first crash, the New York legislature outlawed options and futures trading and imposed a £100 fine on anybody who dared to trade stocks or bonds in public. Trading went on as before — but brokers, to compensate themselves for the new regulatory risks, jacked up their commissions.

The earliest laws in the U.S. generally forbade banks to start up without obtaining a charter from the state legislature.

Lobbying fiercely over charters, banks offered to sell shares at a discount to the state or to legislators themselves, often so cheap they amounted to bribes. In turn, a state might stuff banks with its own bonds at interest rates that reduced its financing costs — and raised the banks’ risks.

No wonder the greatest financier of all, Alexander Hamilton, founded the Merchants’ Bank in New York City in 1803 without even incorporating, and the bank operated without a charter its first two years.

In the early 19th century, bankers were already complaining that “oppressive” regulations prevented them from serving the public profitably.

State laws often forbade banks from lending more than three times their capital, says Eric Hilt, an economic historian at Wellesley College in Wellesley, Mass.

But some still borrowed and lent like mad. In 1809, the Farmers Exchange Bank of Glocester, R.I., became the first significant bank in the U.S. to go bust. It had borrowed $800,000 against less than $200 in total capital.

Federal regulation, other than some efforts by the abortive Bank of the United States, was nonexistent. State law swung from slipshod to punitive as banks’ fortunes rose and fell. After the crash of 1826, prosecutors put some bankers on trial three times, but most were acquitted, partly because the laws they allegedly violated had been too squishy in the first place.

In his State of the Union address in December 1857, after a devastating crash that year, President James Buchanan proposed that states should require banks to back their liabilities with gold or silver and to publish a weekly statement of their financial condition. No one seems to have taken him up on it.

The devastating Panic of 1907 prompted the creation of the Federal Reserve system to supervise banks and monetary policy. That led to sobriety, until the lending orgy of the 1920s and the bank failures of the 1930s. The Banking Act and the Glass-Steagall Act of 1933 imposed another era of constraint, which didn’t loosen until the 1980s.

The flux of financial regulation has real effects. During booms, loose lending and lax regulations foster innovation by drenching entrepreneurs with money. Then, during the inevitable busts, banks retrench and regulators crack down, starving weaker companies of capital. Those alternations of innovation and discipline fuel the crucible of capitalism.

But with regulation in retreat and interest rates looking likely to rise, this may be about as good as it can get for banks. Every deregulation cycle just plants the seeds for re-regulation.

Write to Jason Zweig at, and follow him on Twitter at @jasonzweigwsj.■