What would an unregulated banking system look like? Could an unregulated banking system possibly serve people less well than the current system does?

Some people look at the current system’s failures and say, “We could improve this system if we had tighter regulation.” Others look at the same failures and think, “If only we could deregulate banks along with the entire financial services industry, we would have a much healthier banking system.”

A few points come up here. First, deregulation does not mean an end to fraud prevention. Public authorities always have a responsibility to prevent fraud. Prevention of fraud does not require the strict oversight we associate with regulation. It requires swift punishment of liars and cheats.

Second, deregulation means the whole shmear has to go. No more federal reserve. Small community banks can start up just like any other small business. Large banks can fail, just like any other large business. Let know-how and hard work determine who wins and who does not in the financial services industry.

Third, too big to fail is a load of claptrap, and the people who made up that phrase know it. They made it up to cover the crime they were about to commit, which was to turn over billions of dollars in the public treasury to banks that had failed. How did those banks strong-arm the officials in charge of the public treasury? By suggesting that if they went down, they would take the entire financial system down with them. The officials quailed and took what they thought was the safe route.

Today’s regulatory regime is intended to prevent bank panics and financial system panics. We had a lot of panics in this country during the nineteenth century. The monetary system – along with other elements of the nation’s finances – were not stable entities, to say the least. You couldn’t be sure about the value of your paper money, the value of your stocks, the value of your IOUs, the value of your real estate, or the value of almost anything you might hold. That’s why gold was so popular! So we regulated the financial system to prevent panics, and to give people more confidence in the value of their bank accounts, their investments, and their loans. The efforts to regulate began in earnest during the progressive era, with the establishment of the federal reserve system.

We have seen the results of these efforts over the course of one hundred years. This year the federal reserve system has its one hundredth birthday. Look over the last century and ask whether regulators would care to point to their record of success. For people who never saw a problem the government couldn’t solve, the record probably looks pretty good. For people who are skeptical of government’s ability to solve problems, you might say panics have become less frequent, but more severe when they do occur. As with so many things, we do not find a lot of agreement about the efficacy of regulation for banks and financial services.

In part two, we’ll take a longer look at the qualities we might expect to see in a deregulated environment for financial services.