Garcia, Gillian

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Yale University EliScholar – A Digital Platform for Scholarly Publishing at Yale YPFS Documents (Series 1) Browse by Media Type 11-1-2013 Garn-St Germain Depository Institutions Act of 1982 Gillian Garcia Follow this and additional works at: https://elischolar.library.yale.edu/ypfs-documents Recommended Citation Garcia, Gillian, "Garn-St Germain Depository Institutions Act of 1982" (2013). YPFS Documents (Series 1). 9520. https://elischolar.library.yale.edu/ypfs-documents/9520 This Document is brought to you for free and open access by the Browse by Media Type at EliScholar – A Digital Platform for Scholarly Publishing at Yale. It has been accepted for inclusion in YPFS Documents (Series 1) by an authorized administrator of EliScholar – A Digital Platform for Scholarly Publishing at Yale. For more information, please contact elischolar@yale.edu. Signing Ceremony for H.R. 6267  (Courtesy of the Ronald Reagan Library)Garn-St Germain Depository Institutions Act of1982October 1982Signed by President Ronald Reagan in October 1982, the Act aimed to easepressures on depository institutions as the Fed raised interest rates to curb thehigh in!ation of the 1970s.by Gillian Garcia, GGH Garcia Associates During the 1970s the US economy was plagued by high in!ation. At the time banks and thrift institutions wererestricted from raising their deposit interest rates. Fed Regulation Q  prohibited banks from paying interest ondemand deposits while additional restrictions constrained rates paid on other deposits. These institutionsexperienced disintermediation as households shifted their deposits to unconstrained money market mutualfunds, which o"ered more attractive rates. Corporations increasingly adopted deposit alternatives, such asrepurchase agreements. In October 1979, Federal Reserve Chairman Paul Volcker moved to contain in!ation,and, in doing so, raised market interest rates even further. Depository institutions then became illiquid whenthey were unable to obtain enough deposits to fund their loans.Subsequently, the Depository Institutions Deregulation and Monetary Control Act of 1980 initiated a series oflegislative responses to enable depository institutions to cope better with this adverse environment. This actreleased these institutions from some constraints imposed in the wake of the Great Depression. The Garn-StGermain Depository Institutions Act of 1982 , which President Reagan signed on October 15, was the second inthis legislative series.Regulators had begun slowly removing rate caps in the mid-1970s. But then banks, and especially unhedgedthrifts, incurred losses when the value of their long-term, #xed-rate mortgages fell. These institutions had to paymore for their deposits than they were earning on their mortgage loans, many of which had been made in earlieryears at low interest rates. Thrift failures became increasingly common, and the savings and loan (S&L) industryand its insurer, the Federal Savings and Loan Insurance Corporation, faced insolvency.The Garn-St Germain Act aimed to ease the pressures on banks, thrifts, and their insurance funds. The actexpanded previous deregulation of deposit rates by creating a new money market deposit account (MMDA) forhouseholds that proved to be very popular. It also created a Super NOW account for businesses and governmentagencies. It removed some Depression-era constraints on thrift asset holdings to facilitate higher earnings.Thrifts were newly allowed to make nonresidential and variable-rate mortgages and to change their chartersmore readily (Allardice et al. 1983). Title II of the act preempted state laws that thwarted due-on-sale provisionsin mortgage contracts that forced property sellers to repay their loans. In the absence of due-on-sale provisions,sellers could pass their low-rate mortgages to buyers, thus preventing the lender from earning a higher marketrate on its repaid funds. While these changes were intended to raise thrift earnings, they often back#red wheninexperienced lenders made mistakes, and weak thrifts used the new powers to gamble unsuccessfully forrecovery (Kane 1989). Many lenders, for example, made high-risk loans in commercial real estate projects.Although they were less troubled than thrifts, banks and their holding companies were also experiencingdisintermediation and decreasing pro#tability. The act, therefore, took small steps to assist them. Banks couldo"er the new MMDA and Super NOW accounts. The interest rate di"erential that allowed thrifts to o"erdepositors a one-quarter percent higher rate was abolished. Limits on national banks’ loans to one borrower, onreal estate lending, and on insider loans were relaxed. Unfortunately, many of those banks that were heavilyexposed to the real estate markets failed during the #nancial crisis that began in 2007. Although restrictions onbanks’ insurance activities were increased, restraints were relaxed on relations with their subsidiary banks andon bank service corporation activities that the Fed found to be “closely related to banking.” Holding companiescould henceforth o"er discount brokerage services, but the traditional separation of banking and commerce wasmaintained.As depositors used the new accounts to shift funds from money to near money (highly liquid assets that can beturned into cash), the Fed experienced increasing di$culties in conducting monetary policy. At the time, the Fedguided the economy by controlling the supply of money. Deposit shifts made the velocity of money di$cult topredict, and the Fed subsequently changed its operating procedures to avoid this problem.During this period, the Federal Deposit Insurance Corporation (FDIC) and the state deposit insurance agenciesfound it increasingly di$cult to identify acquirers for the growing numbers of failed institutions. The act,therefore, provided the insurers with emergency powers to breach the 1927 McFadden Act, which had givenstates the authority to regulate bank branching, and other barriers to interstate banking by allowing cross-industry and cross-state acquisitions. This was an early step toward interstate banking, which culminated in theRiegle-Neal Interstate Banking and Branching E$ciency Act of 1994. The Garn-St Germain Act also mandatedseveral studies that later successfully resulted in risk-based deposit insurance premiums and the combination ofthe bank and thrift insurance funds.Some features of the act later proved to be problematic. It gave the deposit insurers emergency powers to aidtroubled institutions that were closed, insolvent, defaulting, and/or experiencing severe #nancial conditions thatthreatened the stability of the #nancial system. Insurers could also assist troubled institutions to reduce theirexposure to loss. They could issue guarantees; purchase or assume the insured institution’s assets or liabilities(but to preclude nationalization, not its common stock); make loans, contributions and deposits in a troubledinstitution or its acquirer; organize charter conversions; arrange extraordinary mergers or acquisitions; and/orissue net worth certi#cates to banks and thrifts with substantial residential real estate loans. Such actionsenabled supervisors to delay closing failed #rms, which allowed recipients to gamble for recovery. Often theywere unsuccessful and increased their and their insurer’s losses. In reaction, the prompt corrective-actionprovisions of the FDIC Improvement Act of 1991 (FDICIA) required the FDIC to use the least costly form ofresolution and mandated supervisors to close an institution before it became book-value insolvent. During therecent #nancial crisis, the pendulum swung again when the US Treasury used the Troubled Asset Relief Program to inject capital into troubled #rms, and the Fed and the FDIC provided unprecedented #nancial assistance to#nancial institutions.Title VIII of the Garn-St Germain Act allowed lenders to make alternative mortgages, some of which proved to beproblematic during the recent #nancial crisis. Some unrestrained lenders, for example, o"ered infamous 2/28adjustable-rate mortgages to entice subprime borrowers to initiate loans at low rates, only to #nd that they couldnot a"ord the payments when the mortgage quickly reset at a much higher rate. Millions of foreclosures ensued.There are two important lessons from this experience. First, rising interest rates impose losses on unhedgeddepository institutions that hold long-term, #xed-rate loans made at low rates. Second, hiding, instead ofresolving, the industry’s problems can increase the severity of those problems and augment the losses thatultimately fall to investors or taxpayers or both.EndnotesMs. Garcia was formerly a senior economist at the Federal Reserve Bank of Chicago.BibliographyAllardice, David, Herbert L. Baer, Elijah Brewer III, Thomas F. Cargill, John Dobra, Gillian Garcia, Anne MarieGonczy, George G. Kaufman, Robert D. Laurent, and Larry R. Mote. “The Garn-St Germain Depository InstitutionsAct of 1982.” Federal Reserve Bank of Chicago Economic Perspectives 7, no. 2 (March 1983): 3-31.Kane, Edward J. The S&L Insurance Mess: How Did It Happen? Washington, DC: The Urban Institute, 1989.Depository Institutions Deregulation and Monetary Control Act of 1980.  Pub. L. No. 96-221, 94 Stat. 132 (1980).Riegle-Neal Interstate Banking and Branching E$ciency Act of 1994 . Pub. L. No. 103-328, 108 Stat. 2338 (1994).Federal Deposit Insurance Corporation Improvement Act of 1991.  Pub. L. No. 102-242, 105 Stat. 2236 (1991).Written as of November 22, 2013. See disclaimer.Share +11Paul A. Volcker ChairmanBoard of Governors1979 – 1987Related EssaysFederal Deposit InsuranceCorporation Improvement Act of1991Depository InstitutionsDeregulation and MonetaryControl Act of 1980Riegle-Neal Interstate Bankingand Branching E!ciency Act of1994Savings and Loan CrisisThe Great In"ationRelated PeopleRelated LinksText of Act @FedHistory Terms of Use  • Privacy Policy  • Contact UsThe Fed's Functions  Related Resources Search Federal Reserve HistoryYour Gateway to the History ofthe Federal Reserve System TOPIC TIME PERIOD PEOPLE

Garn-St Germain Depository Institutions Act of 1982

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