The Public Trough: Welfare for Bankers

There is a battle shaping up in Washington which appears to be a classic example of big businessmen fighting to retain a government privilege at the expense of consumers. The basic issue is this: Regulation Q sets the maximum rate of interest that can be paid by banks and savings and loans on passbook accounts. Currently, banks may pay up to 5% and other thrift institutions may pay 5¼%. Obviously, this is a great deal for the bankers and a terrible deal for savers. Banks get their money from small savers at 5%, lend it out for three-months to the Treasury for better than 9%, and the difference is their profit. Meanwhile, with inflation rising at the rate of 9% per year, savers are only losing 4% of their money per year. (Actually, it is more than 4% because taxes must be paid on the interest income.)

When the interest paid on Treasury bills went above the Regulation Q ceilings in 1977, the bankers began complaining that the Treasury was draining their funds, as people withdrew their savings and bought Treasury bills. In order to help the banks, the government allowed them to issue special six-month certificates paying the market rate of interest. The catch was that, like Treasury bills, you could only buy these money market certificates in denominations of $10,000. Clearly, this excluded the vast majority of savers who were stuck with 5% passbook accounts while the “fat cats” got almost twice that.

In February, Senator William Proxmire, chairman of the Senate Banking Committee, suggested that maybe small savers ought to get some benefit from current high interest rates also. He introduced S. Res. 59 (which does not carry the force of law) asking the bank regulatory agencies to allow banks to offer money market certificates in denominations of $1,000, instead of $10,000. And the bankers have been screaming ever since. They realize that if savers could get the market rate of interest by investing only $1,000 then Regulation Q is effectively eliminated.

There are really no good arguments for not eliminating Regulation Q. It’s true that many banks would be in serious trouble, because they have been loaning out money for mortgages and the like long-term and covering the loans by borrowing short-term. As long as short-term interest rates stayed below long-term rates (as they usually do) they were okay. But short-term rates are now considerably above the interest rates banks were getting for long-term money just a short time ago. Thus there will be a squeeze on bank profits as the banks’ cost of obtaining money climbs even higher.

It is inevitable that these kinds of problems are going to arise whenever an industry has been developed based on a special favor from government. In any case, the banks would be in far less trouble than they are if they had only followed sounder banking practices, and thought of themselves more as trustees for their depositors’ money.

The prediction of doom to our banking system from Regulation Q’s demise, however, cannot be justified. For one thing, everyone seems to be forgetting that an increase in the reward for saving (i.e. higher interest) will certainly have an effect on the rate of savings. In other words, more funds will be made available to the banks. This in itself will help ease pressure on interest rates and bring them back down again.

The idea that savers save to get a return on their money, rather than out of habit or something, is foreign to the bankers. They refuse to accept the idea that higher interest will increase savings and will not only increase their costs. Unfortunately, Professor Michael Boskin of Stanford has clearly shown that the rate of savings is responsive to the return on savings (see “Taxation, Saving, and the Rate of Interest,” Journal of Political Economy, April 1978).

Another important factor that is forgotten is that real interest rates are really quite low. The real interest rate is the market rate less the anticipated rate of inflation. Thus if you were to loan money for a year during which time you expected inflation to rise 10% then it would not be unreasonable for you to ask for 15% or more on your money, since the real interest rate would only be 5%. In other words, it may be quite proper under current circumstances for interest rates to be much higher than they already are.

In the final analysis, Regulation Q must go, not for economic reasons but for moral ones. It is just not right to force small savers to subsidize large savers and bank profits. If this means putting a few banks out of business in the process, it still needs to be done.