Adolf and Catharina Croeser, Known as ‘The Burgomaster of Delft and his Daughter’, Jan Havicksz. Steen, 1655.
By S.L. Mintz
A heated debate these days has mobilized advocates for public banks. Using financial resources available to state and local governments, they would form institutions that charge below market interest rates and slash banking fees. Savings at a Bank of Los Angeles County, if one existed, might liberate hundreds of millions of dollars to rebuild bridges, tunnels, schools, roads, water mains and other vital infrastructure.
Praise is not universal. Critics fear potential for mismanagement and corruption that crippled earlier attempts to operate public banks ever since 1408, when a medieval prototype in Genoa, Italy, proclaimed a mission that still resonates, “to eradicate certain bad practices of bankers, who are so devoted to their own interests that they barely blush as they ruin the public good.” Loans to the sponsoring government eventually spelled doom, according to Mark Calandria, writing in an op-ed for the American Banker. A former director of financial regulation studies at the libertarian Cato Institute, Calandria became chief economist to vice president Pence in February.
Public banks exert appeal nevertheless as stakes climb. An April 2018 report by the Los Angeles County treasurer and tax collector reveals $29 billion in “pooled surplus investments.” These funds reside with managers in the private sector, untouched except when other resources that keep the city operating come up short. The vast majority sits in United States Government and Agency Obligations and Certificates of Deposit.
Why should the private sector manage that cash when it could furnish the capital foundation for a public bank? Suitably capitalized and empowered to borrow at interbank rates or tap securities markets, a public bank could sweep up expensive county debt or make infrastructure loans with long time horizons that command sky high interest in the private sector.
Attorney Ellen Brown launched the Public Banking Institute in 2010 to lobby for change. Public banks, Brown argues, would not explode price tags for essential infrastructure projects.
When residents of Yorba Linda and Placienta, California, approved a $200 million school construction bond, they got a nasty surprise. “Just one $22 million borrowing from 2011 will cost taxpayers nearly 13 times that amount — $280 million — to repay,” the Orange County Register reported in 2015. The newspaper reported that hundreds of school districts, including 14 in Orange County, have signed up for similar deals, called capital appreciation bonds, to build or refurbish crucial infrastructure.
All fees paid to bankers by LA County in 2013 exceeded $200 million, a coalition of community organizations and unions reported, while sidewalks, alleys, roads and sewers languished.
Interest payments to public banks goes into local public coffers instead of deep-pocketed banks and investors dispersed around the world, says Brown. Public banks also furnish depository alternatives to big banks whose dubious practices have triggered massive penalties since the great recession. In a bigger picture, public banks without profit motives face less temptation to indulge in risks that cause financial crises. As for transparency and accountability that alarm skeptics, Brown insists that technology can shrink those risks to nearly nil.
The newest proposals are more nuanced than shifting government funds from private to public institutions. A municipal bank could form large networks of investors populated by pubic treasuries, pension funds, foundations, socially responsible investment funds and individuals, says economic consultant Karl Beitel, the author of “Municipal Banking: An Overview,” published in 2016 by the Roosevelt Institute.
The “big bang,” says Beitel, recaptures cash flow lost to the private sector. LA County currently allocates around $15 billion in its investment pool to buy very safe US government securities. The cash paid for these securities flows into the reserves of major banks, financial funds, other municipalities and hedge funds. Simultaneously, the county borrows money via underwriters on the municipal market from high net worth investors elsewhere in California and the U.S.
A public bank could use funds in the investment pool to buy notes or to make deposits in the bank. Armed with ample capital, the bank could lend funds to small business, housing initiatives or infrastructure development. Moreover, the bank can bundle these loans into pooled securities for sale to its investment network, bypassing Wall Street. Additional twists tap markets in other ways that advance the LA County economy, among the world’s largest.
Can it work? Some advocates point to the Bank of North Dakota, a state-owned central bank funded with taxpayer dollars since 1919 and profitable right through the recent financial crisis. Others favor public banks that resemble a modern wholesale financial corporation. “The problem is not a shortage of capital,” Beitel says. “The problem is how to capture and redirect it.”
A public bank will work if politics don’t get in the way, says Beitel. “It involves getting people outside the box and local bureaucracies, particularly treasury departments and pension funds, to contemplate a different way of doing business.” It is still too soon to bank on the outcome.
S.L. Mintz has served in key editorial posts for CFO Magazine, American Banker and Corporate Finance Magazine and helped write The Financial Crisis Inquiry Commission Report for the U.S. Congress.