Laissez-faire is a French tern which means – “leave it alone” was first adopted by U.S. Government policy for the purpose of economic theories. Adam-Smith, 18th Century Scot who influenced to the growth of American Capitalism earned fame through the economic theory writings and also introduced the term Laissez-faire. Government regulations are of two categories the first being economic regulations and the second being social regulations. Economic regulations seeks to control prices whereas social regulations deal with safe workplaces, retirement benefits, tax breaks and clean environment. After World War II, American banking system restored its financial health as the New Deal legislation produced good results and difficulties began only in 1980s and 1990s partly due to social regulations. Savings and loan (S&L) industry was concentrating on long-term loans, termed as mortgages. Mortgages term was nearly 30 years which carried a fixed interest whereas deposits were being paid short-term interest rates. As and when short-term interest rates rise above long-term mortgage interest, S&L industry would incur loss of money. There arised a need to control interest rates on deposits made.
As the financial system was doing well in 1960s and 1970s many Americans purchased homes through S&L. In 1980s, the depositors were expecting higher returns by investing money in market funds and other assets which are in non-banking sectors. This has resulted in financial shrink for banks, as there were no new depositors to invest in large portfolios as long-term investment. For any financial sector, the liquidity must be continuous bringing new funds apart from outflow of funds or vice-versa. When there is complete diversification of funds, banking sector or any other financial sector runs out of cash flow making it most difficult to operate on funds flow.
As a result of these problems, the Government in 1980s lifted the interest rate ceilings on bank and S&L deposits. Although this helped in inviting deposits again from customers, resulted in large amount of losses on S&L mortgage portfolios. Responding again, Congress relaxed restrictions on lending to enable S&L industry to make higher-earning investments. Further Congress permitted S&L industry to perform business in consumer, commercial and real-estate lending. S&L expanded its activities into high risk areas such as real estate ventures which are speculative and in many cases, these real estate ventures resulted in quoting loss especially when economic conditions were unfavorable resulting in further shrinking of S&L in huge losses. Government reaction to this blow of crisis and loss in S&L plunged U.S into a financial crisis and scandal that stayed for many long years in America history and large numbers of S&L industries became insolvent and many were liquidated which includes The Federal Savings and Loan Insurance Corporation. In 1989, Congress promulgated Financial Institutions Reform, Recovery and Enforcement (FIRREA) Act which provided $ 50 billion to S&L and a new government agency Resolution Trust Corporation (RTC) was set up to liquidate insolvent institutions and for the purpose of this, in March 1990, another $ 78,000 million were invested in RTC to clean up S&L and rejuvenate the activities of S&L industry. Americans learnt many financial lessons and collected rich experience in banking regulations. Government protects small savers who enable to maintain the stability of banking system and also reduce the dangers that befall on banks. Interest rate controls in banking sector do not produce optimum results and investments must be determined on the basis of market forces and on the basis of economic conditions and bank lending must be closely watched and must be limited.
Finally insolvent banks must justify with depositors either by paying off or by transferring the deposits to other banks. American investors believe that government provides a continuous support and supervision in preventing risky lending and economic policies that damage the entire economy. Regulators emphasize on periodical disclosure of financial status and banks also must act responsibly by public disclosure of financial workings.
The Role of Government in the Economy
Accessed June 24, 2008