Bank Smarter: How Falling Oil Prices Sparked A Banking Revolution | NerdWallet

We all know that mortgage rates have taken us on a bit of a rollercoaster ride, reaching record lows back in 2020 and more than doubling by 2023, while savings rates have been over there doing their own little rollercoaster ride too. I spent the past three months just digging into the history of interest rates, you know, like you do, and everything just kept leading me back to the gas pump. What a lot of people don't know is that the cost of gas back in the 80s actually helped lay the foundation for those chaotic interest rates of today. Before I get to that, let me back up because one thing that we have to first understand is that between 1921 and 1929, more than 600 banks per year failed. Those numbers are unheard of now. Remember how shocked everyone was when Silicon Valley Bank failed? It's just, it's not something that we're used to having to deal with because of the Federal Deposit Insurance Corporation, or FDIC. The FDIC was created back in the 30s to help regulate deposit interest rates and separate commercial banking and investment banking, which maintained stability and confidence in the nation's financial system. And it meant less bank failures. Now, around the same time that the FDIC was being built, the Federal Reserve, aka the Fed, got more centralized power. You hear all the time about the Fed doing this or that to interest rates. Well, they were out there mostly doing this or that to interest rates between the 1930s and the 1980s. For decades, things were mostly okay. I mean, there was a degree of banking stability, and there was some economic expansion. But bubbling under the surface was a lot of criticism around the regulations, mainly that banks couldn't be innovative or creative because of the limits put onto them by the FDIC and the Fed. So, in 1980, in swoops President Jimmy Carter, and he signs the Depository Institution's Deregulation and Monetary Control Act. And after this, all banks were forced to abide by the Fed's rules. It changed a bunch of regulations, but most notably for our conversation, it allowed institutions to charge any loan interest rates that they wanted and removed the Fed's power to regulate maximum interest rates on deposits. It worked out for us as consumers. It freed up financial markets so banks could compete for depositors' funds, which increased savings and helped markets function more smoothly. So over here, you have deregulation allowing more lending and for interest rates to climb higher and higher and higher, at one point reaching as high as 8% as banks are out there competing to get depositor funds. But over here in the background, we have these other economic issues brewing. Inflation was at 14%. 14%. For perspective, good inflation would be about 2%. The high inflation rate meant that consumer prices were skyrocketing, which would eventually lead to a housing crash. There was a mounting oil glut that had been going on since the late 70s, which ironically came about from a shortage of oil in the early 70s. But by the late 70s, an increase in oil supply and a decrease in consumer demand would ultimately lead to a sharp drop in the price of oil throughout the 80s. I mean, let's be real, this was another solid temporary win for consumers considering the price of the pump was under $1 per gallon in some areas. But it was creating some pretty significant challenges for financial institutions. So significant that one of the largest banking failures of all time happened in the 80s. 1,617 commercial and savings banks were closed or received FDIC assistance between 1980 and 1994. I talked about the FDIC earlier and how they're tasked to sweep in and solve banking problems. Well, of the billions of FDIC incurred resolution costs related to those bank closures, half of them came from banks in the Southwest. Most significantly, Texas. And what's one of the first things that comes to mind when you think about Texas? Besides maybe a football team that can't make it to the Super Bowl. Sorry, mom. Texas, along with other states in the Southwest, including Oklahoma, Louisiana, New Mexico, and Arkansas, built their economy's foundation on oil. In 1973, the average import price for crude oil monthly was $2.75 per barrel. But then those behind-the-scenes oil things that I mentioned earlier started happening, driving the price up to a peak of almost $37 per barrel in April of 81. So obviously, if you're Mr. Bank Owner of Texas at the time, that oil price boom is going to encourage you to lend further to energy markets, which would mean prosperity for your local economy. And if you have this bustling economy with lots of money flowing through, you need to have enough financial institutions to handle it all, right? In the decade between the 1980s and early 90s, the net effect of failures, new bank charters, conversions, and other banking changes was an addition of 793 banks. 793! Just to help you conceptualize how astronomical that number is, only 81 new banks were chartered in the entire U.S. since 2010. It's like they were giving banks away. But alas, all good things must come to an end. The oil prices peaked in 1981 and then started their steady decline. These significant shifts rocked the stability of banks in the Southwest, though many bankers ignored the advice of analysts and just assumed the turbulence wouldn't last. Meanwhile, you have investors over there riding on the highs of all this money from the oil boom, and they're looking for something to do with the liquidity. So they started aggressively funding real estate development. But no, when I say aggressive, I mean to the point where it was concerning. They're building all this commercial property, but it was sitting empty. At one point in 1985, Dallas had 34 million square feet of unleased office space. This surplus of real estate, combined with the contraction of oil prices reducing the economy, meant a lower demand for office real estate and reduced the value of real estate in the region. Now, you have to think about the ripple effects that come from some of these things, right? You have the oil industry taking a hit, which means a desperation for lenders to find another industry to invest in, but also a reduction in jobs. A reduction in jobs means an exodus of people leaving the area in search of work. When there were all these layoffs happening and people couldn't afford their mortgages, foreclosure rates were in excess of 60% in some communities. Earlier, I said that deregulation allowed for interest rates to soar. Well, that rate that at one point reached 8% started to significantly decrease since financial institutions couldn't sustain them anymore. As banks started failing, savings account rates decreased dramatically, down to somewhere between 4% and 5% in the 90s. Remember that banks incentivize prospective members to deposit into the institution's savings accounts by enticing them with higher interest rates. The bank will then use the money to fund new loans for other members, and those members will pay a higher interest rate on their loans so that the bank can make money. But if the bank doesn't have a need for depositors' money, they may decrease interest rates. And that's exactly what happened. While not a perfect science, you can look at most turbulent economic times in the last few decades and see oil prices and banking stability sharing some sort of connection. The energy sector continues to be a prominent industry for investors' investment dollars. In fact, gas investments are expected to reach $171 billion by the end of this year. So when there's foreign unrest that can impact the availability of oil, or a decrease in demand as electric vehicles gain in popularity, or anything else that might impact the cost of a barrel, banks feel it in some capacity and vice Last year amidst the impending banking crisis when First Republic, Silicon Valley, and Signature Banks all failed, scared money managers sold the equivalent of 139 million barrels of oil, sending prices into yet another state of turmoil. Look, the bottom line is oil and gas, along with commercial banks, are among the top 10 biggest global industries in terms of revenue, so it makes sense that these two's ups and downs would go hand in hand. It's easy to get upset about it when you really dig into it since we're the ones who ultimately pay the costs in most cases. But we got some stuff out of it too, some good stuff. All the bank fluctuations have paved the way for new options for us consumers over the years. Fintech companies like neobanks helped make high-yield savings accounts more commonplace, and you can find interest rates that are higher than the national average savings accounts rates at these institutions now. And the confusion that consumers went through in the past also means that prioritizing financial education has become more important for companies of today. So how can you use this little bit of a history lesson to your financial advantage? Three ways come to mind. One, continue to have a diverse investment portfolio. The market, it's unpredictable, so a diverse mix of stocks, bonds, and cash is a good rule of thumb. Two, consider a certificate of deposit, or CD, for your long-term savings goals when rates are high. This could help you take advantage of impressively high interest rates without the risk of a market shift dropping them back down the way they might with standard savings accounts. And then three, look at your own finances when you're contemplating making a major purchase, like buying a home, instead of letting market fluctuations decide for you. With interest rates in mortgages sitting uncomfortably high, many potential buyers are hanging on the sidelines waiting to see if things will improve, and many sellers are afraid of giving up the good rates they're currently locked in at. If you'd been considering buying a home in 1973 and thought that you'd just wait until rates drop back down, y'all, you would have been waiting until the early 90s. Look at your personal situation and determine if it makes sense for you to make a purchase right now. Don't let yourself get pressured by great rates to make a move, or scared off by higher rates to not make a move. Thanks for watching Control Finance. Want to learn more about how things impact the economy? Do a search here on the NerdWallet YouTube channel for my video on the impacts of climate change on the economy. I'll see you there. Bye!