Deregulation: Definition, History, Effects, and Purpose

What Is Deregulation?

Deregulation is the reduction or elimination of government power in a particular industry, usually enacted to create more competition within the industry. Over the years, the struggle between proponents of regulation and proponents of government nonintervention has shifted market conditions. Historically, finance has been one of the most heavily scrutinized industries in the United States.

Understanding Deregulation

Proponents of deregulation argue that overbearing legislation reduces investment opportunity and stymies economic growth, causing more harm than it helps. Indeed, the U.S. financial sector wasn’t heavily regulated until the stock market crash of 1929 and the resulting Great Depression. In response to the country’s greatest financial crisis in its history, Franklin D. Roosevelt’s presidential administration enacted many forms of financial regulation, including the Securities Exchange Acts of 1933 and 1934 and the U.S. Banking Act of 1933, otherwise known as the Glass-Steagall Act.

The Securities Exchange Acts required all publicly traded companies to disclose relevant financial information and established the Securities and Exchange Commission (SEC) to oversee securities markets. The Glass-Steagall Act prohibited a financial institution from engaging in both commercial and investment banking. This reform legislation was based on the belief that the pursuit of profit by large, national banks must have spikes in place to avoid reckless and manipulative behavior that would lead financial markets in unfavorable directions.

Over the years, proponents of deregulation steadily chipped away at these safeguards until the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which imposed the most sweeping legislation on the banking industry since the 1930s. How did they do it?

The History of Deregulation

In 1986, the Federal Reserve (Fed) reinterpreted the Glass-Steagall Act and decided that 5% of a commercial bank’s revenue could be from investment banking activity. In 1996, that level was pushed up to 25%. The following year, the Fed ruled that commercial banks could engage in underwriting, the method by which corporations and governments raise capital in debt and equity markets. In 1994, the Riegle-Neal Interstate Banking and Branching Efficiency Act was passed, amending the Bank Holding Company Act of 1956 and the Federal Deposit Insurance Act, to allow interstate banking and branching.

Later, in 1999, the Financial Services Modernization Act, or Gramm-Leach-Bliley Act, was passed under the watch of the Clinton administration and overturned the Glass-Steagall Act completely. In 2000, the Commodity Futures Modernization Act prohibited the Commodity Futures Trading Commission from regulating credit default swaps and other over-the-counter (OTC) derivative contracts. In 2004, the SEC made changes that reduced the proportion of capital that investment banks have to hold in reserves.

This spree of deregulation, however, came to a grinding halt following the subprime mortgage crisis of 2007 and the financial crash of 2007–2008, most notably with the passage of the Dodd-Frank Act in 2010, which restricted subprime mortgage lending and derivatives trading.

However, with the 2016 U.S. election bringing both a Republican president and Congress to power, then-President Donald Trump and his party set their sights on undoing Dodd-Frank. In May 2018, Trump signed a bill that exempted small and regional banks from Dodd-Frank’s most stringent regulations and loosened rules put in place to prevent the sudden collapse of big banks. The bill passed both houses of Congress with bipartisan support after successful negotiations with Democrats.

Trump had said that he wanted to “do a big number” on Dodd-Frank, possibly even repealing it completely. However, former Rep. Barney Frank (D-Mass.), its co-sponsor, said of the new legislation, “This is not a ‘big number’ on the bill. It’s a small number.” Indeed, the legislation left major pieces of Dodd-Frank’s rules in place and failed to make any changes to the Consumer Financial Protection Bureau (CFPB), which was created by Dodd-Frank to police its rules.

What Are the Effects of Deregulation?

The hoped-for effects of deregulation are to increase investment opportunities by eliminating restrictions for new businesses to enter markets and increase competition.

Increasing competition encourages innovation, and as companies enter markets and compete with each other, consumers can enjoy lower prices.

Lessening the need to use resources and capital to comply with regulations allows corporations to invest in research and development.

Without needing to comply with mandated restrictions, businesses will develop new products, set competitive prices, employ more labor, enter foreign countries, buy new assets, and interact with consumers without the need to obey regulations.

The Bottom Line

Deregulation lowers costs of operations, allows more businesses to enter a market, and lowers prices for consumers. These factors can help stimulate efficiency and lead to increased economic growth.