Establishing the Banking Regulator in the United States 1930’s

Some bank reforms of the thirties may have been overvalued. The Glass-Steagall Act created new endogenous risks implying possible systemic effects. Deposit insurance failed to address the main cause of banking panics, the prohibition of bank branching preventing diversification of idiosyncratic risks while reinforcing inefficient unit banks. Separation of commercial and investment banking avoided certain conflicts of interest at an opportunity cost associated with rejecting universal banking. Moreover, the regulator was captured by the regulated as it expressed a preference toward an aggressive participant in a duopolistic conflict.

On the opposite, major innovations in bailout process and prudential regulation appeared underestimated. The Reconstruction Finance Corporation of 1932 established the investor of last resort giving the Treasury the authority to recapitalize an insolvent financial institution deemed too big to fail. The banking regulator, the Federal Deposit Insurance Corporation of 1933, was given a special bank-closure rule, different from the usual bankruptcy proceedings, which allowed for orderly resolution of failing banks with a view to protect the economy from systemic risk.