The political lessons of Depression-era banking reform

Abstract

Ironically, the primary motivations for the main bank regulatory reforms in the 1930s (Regulation Q, the separation of investment banking from commercial banking, and the creation of federal deposit insurance) were to preserve and enhance two of the most disastrous policies that contributed to the severity and depth of the Great Depression – unit banking and the real bills doctrine. Other regulatory changes, affecting the allocation of power between the Fed and the Treasury, were intended to reduce the independence of the Fed, while giving the opposite impression. The ill-conceived banking legislation of the 1930s took very little time to pass, but a great deal of time to disappear. The overarching lesson is that the aftermath of crises are moments of high risk in public policy. The Great Depression provoked banking reform legislation that was quick, comprehensive, and unusually responsive to popular opinion. Each of these three aspects increases the risk that regulation will have adverse consequences.