Gaby Lapera: So, OPEC. There's this manufactured oil and energy crisis in the Unites States
in the 1970s. This is what people think about when they think about the cars lining up at
the gas stations and oil rationing. People could only go in depending on what your license
plate number ended in, and stuff like that. John Maxfield: What's so funny is that people
... I don't know how well-known the oil crisis of 1973, that was the first one, there was
another oil shock and lit later 1970s. The oil shocks in the 70s, they fundamentally
transformed the financial industry in the United States. The reason that happened was,
you had these really strict regulations coming out of financial crisis that, among other
things, limited ... They set a cap on the interest rate that banks could pay on deposits.
When you had the oil shoot up ... I mean, I can't remember exactly ... I mean, it went
up from what, $1 a barrel... Don't quote me on exactly ... I'm just saying this to illustrate
the magnitude. It went up from $1 a barrel to something like $80 a barrel. It was a huge,
huge increase. That triggered very rapid inflation in the United States. When you have inflation,
you also have interest rates increasing and increasing and increasing. The banks were
stuck in this position where they were having to pay 20% to borrow money. They were then
lending out on these fixed rate 30-year mortgages that were on their books for 8%.
It created this really bad situation for banks that caused them to do multiple different
things. The leader of the group that was really pushing change and transformation in the bank
industry was a guy named Walter Wriston at what is now Citigroup. What he did is, he
said, look, we need to unchain the interest rates that banks pay to borrow money from
what was the regulation queue which was the cap. He came up with all these innovations
that unchained that. Then he also was pushing ...
Lapera: Hold on, go back a second. Maxfield: Go for it.
Lapera: What was regulation queue for? Why did this cap exist in the first place?
Maxfield: The theory behind regulation queue, there's a couple different things, but the
main theory behind regulation queue is that if you go back all the way to the gilded age
and before that, banks that would pay at a high rate of interest for their deposits were
generally more susceptible to failure. Because then, if they got into trouble, the reason
that people had money there was almost as an investment. So they would pull it out very
quickly, as opposed to just putting it there and forgetting about it. The other reason
that regulation queue was in effect was that the United States wanted to promote local
lending by savings banks, or savings and loans. What they did is they allowed savings and
loans to charge a higher interest rate to gather deposits, then they allowed commercial
banks, because commercial banks would then theoretically take the money that was deposited
in rural areas and bring it to money centers, which would then drain that money out of there.
Lapera: This leads us back to the energy crisis and these banks that are paying out these
interest rates on the deposits that are 20%+ and then having these loans that are 8%. This
is what led to the savings and loans crisis of the 1980s, which is where a ton of these
small banks just collapsed. They just disappeared. They got bought up by bigger banks, because
they just couldn't function anymore. Maxfield: Literally, many, many thousands
of savings and loans thrifts and banks failed during the 1980s in particular as a result
of that. You can think about it like this. It would be like if you run a book store and
you are buying books for $20 a book and selling them for $8 a book. Not a very good business
model. Lapera: Then you get to Walter Wriston who
says “I think that we can do better than this.”
Maxfield: He says look, there's two ways that we can get around these interest rate caps.
The first way is that we can issue negotiable certificates of deposits, CDs. Negotiable
CDs that were not capped by those interest rate requirements. They could bring in all
this money from big corporations that needed to get interest on their money, but they wanted
it in safe big banks. The second thing that Wriston and Citigroup did was they said, look,
we can go to what's called the Euro dollar market, which after you had that explosion
in the energy crisis, you have all these dollars, because oil trades in dollars, all these dollars
accumulating abroad because Saudi Arabia was accumulating, Venezuela, all these other countries
were accumulating these dollars. Those dollars stayed in Europe and stayed overseas but they
were not susceptible to those interest rate caps, so banks could borrow those dollars
for either, they could pay more to borrow those dollars, or they could pay less depending
on what it was. What mattered was that they were not limited by regulation queue.
They did one other thing at Citigroup that allowed them to finance the bank through ways
other than your poor deposits. They started issuing commercial paper at the bank holding
company level. Basically what this did to banks, is it transformed them from these depository
institutions, to basically highly leveraged financial funds that deposits only provided
some of the funding for.