In Search of the Banking Regulator amid U.S. Financial Reforms of the 1930s

Some bank reforms of the 1930s in the United States may have been overvalued. The Glass-Steagall Act of 1933 actually created new endogenous risks involving potential systemic effects. Deposit insurance failed to address the main cause of banking panics, and rather strengthened inefficient unit banks, while the prohibition of interstate bank branching continued to hinder banks to diversify idiosyncratic risks. The separation of commercial and investment banking put an end to certain conflicts of interest but it created an opportunity cost by preventing universal banking from developing effectively. Finally, an untimely intervention in a duopolistic conflict made the regulator a captive figure. By contrast, major innovations covering bailout processes and prudential regulation appear to have been underestimated. The Reconstruction Finance Corporation of 1932 established the foundations of an investor of last resort, giving the Treasury the authority to recapitalize insolvent financial institutions deemed too big to fail. The newly established banking regulator, the Federal Deposit Insurance Corporation of 1933, was given a special bank-closure rule, separate from the usual bankruptcy proceedings, which opened a way towards orderly resolution of failing banks in order to protect the economy from the spread of systemic risk.