October 04, 2017
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American Public Banking

At the beginning of March, responding to the impressive wave of state-level public banking movements in the news, Mark Calabria of the Cato Institute wrote a template that became two different published OpEds. The Denver Post titled Calabria’s piece “Colorado would be wise to reject state-owned banking,” while American Banker titled the piece “Promises of Public Banks Don't Match Reality.” The wording differs in the two pieces, but the message points are the same. In the course of delivering those points, Mr. Calabria distorts other scholars’ published research, gets some historical anecdotes wrong, and plays on tired old fears of “government control” while glossing over the rampant, widespread corruption of Wall Street banking.

Although ostensibly associated with libertarian thought, Cato really argues in the interests of its supporters, who, in addition to the Koch family, include American Express, Chase Manhattan, CME Group, and Citicorp/Citibank. Mr. Calabria does not disclose Cato’s or his own financial interest in maintaining those corporations’ business, which might well be undercut by the success of both public and community banks. These are not “libertarian” interests in the sense of being genuinely committed to local control or even qualitatively less regulation. These companies know that regulatory systems covering powerful private banks are easier to game, and the rewards are big for those who can play the system. Public banks are regulated too, but their structurally limited power and absolute transparency create substantially fewer incentives for corruption. That Mr. Calabria can’t find any anecdotes of corruption from a currently existing public bank nearing 100 years of age (the Bank of North Dakota) is more informative than his Bill and Ted-style trip through history.

We can extract nine major arguments from Mr. Calabria’s piece:

1. Historically, public banks have failed because of governmental involvement and corruption.

Again, this has not been true in the case of the Bank of North Dakota, which has neither failed nor been subject to corruption. Mr. Calabria attempts to indict the BND for different reasons later, but BND is the most topical example in this discussion, and it isn’t failing and it isn’t corrupt.

As for pre-BND history, Mr. Calabria gets some of it wrong, beginning when he mis-identifies the first known public bank. This isn’t worth slogging through, though; Mr. Calabria is doing little more in his historical treatment than making extremely subjective claims without citations, covering a rather large span of history. It’s impossible to make any generalization about government-involved banking in early American history, because there were so many different ways to do it. In Politics and Banking: Ideas, Public Policy, and the Creation of Financial Institutions, Susan Hoffmann explains:

Between the two extremes of mostly private commercial banks and almost entirely public state central banks there existed just about every arrangement imaginable. The state shared in ownership of some banks but not in governance (beyond specifying the banks’ constitutions). When the state was involved in a bank’s governance, its representation on the board of directors ranged from minimal to a majority plus public selection of the president. The capital of state banks consisted of various combinations of specie, mortgages on land and slaves, and bonds issued by the chartering state, other states, or the United States.

Readers are urged to read Ellen Brown’s The Public Bank Solution for a historical treatment of public banks dating from 3,000 BC to the present. Ms. Brown’s treatment doesn’t sugarcoat the problems some public banks had. But placing those problems next to the problems created by too-big-to-fail banks will give readers a sense of perspective.

2. The failure of the Vermont public bank of 1806 is an indictment of public banks.

Jim Hogue’s excellent analysis of the Vermont State Bank reveals, yet again, that Mr. Calabria’s analysis is selective and oversimplified. Profits at the VSB were $11,000 in 1808, $22,000 in 1809, $33,000 in 1810, and $44,000 in 1811. Governor Galusha, who had initially opposed the bank, admitted that “the establishment of a public bank in this state has saved many of our citizens from great losses, and probably some from total ruin.” Private corrupt financial interests ended up undermining and discrediting the bank, apparently on purpose.  Vermont-based journalist Ken Picard calls the closure of the State Bank “inexplicable,” pointing out, as does Hogue, that the bank was profitable and enjoyed widespread political support. Hogue’s most important conclusion is that the reasons for both the creation and the ultimate demise of the Vermont State Bank underscore the need for banking to be a public utility instead of a private business.

3. Fannie Mae and Freddie Mac illustrate the failure of government involvement in banking.

Fannie Mae and Freddie Mac had little to do with the housing bubble of the late 2000s; Wall Street capitalists peddled their high-risk subprime schemes beyond the Freddie and Fannie system, and it was private-label securities rather than anything done by Fannie and Freddie that led to the financial meltdown, according to the bipartisan Financial Crisis Inquiry Commission. Fannie and Freddie indeed failed due to bad business decisions, but there is no connection between those decisions and the kinds of mandates that would be contained in a public banking charter; Mr. Calabria doesn’t even assert that any such similarities exist. One recurring conclusion readers can’t help but make as they compare Cato’s work to PBI’s is that both public and private institutions can get it right, or not get it right. The public banking movement seeks to create public financial institutions that responsibly support community-oriented private ones.

4. The German Landesbanken carried the bulk of losses related to the 2008 subprime crisis.

Arguing that the German Landesbanken were responsible for subprime crisis losses ignores the pressure the big banks exerted on  the German public banks to accept risky securities and debt obligations. In any case, BND and German banks still weathered the Great Recession better than their private counterparts. Evidence much more recent than what Mr. Calabria relies upon concludes that the Landesbanken have been, and continue to be, highly successful public banks. Germany has 11 regional public banks (Landesbanken) and several municipal public banks for consumers (Sparkassen). We’ll discuss Sparkassen a bit later. Concerning Landesbanken, Ellen Brown explained in 2012:

Germany and Japan are export powerhouses, in second and third place globally for net exports. (The U.S. trails at 192nd.) One competitive advantage for both of these countries is that their companies have ready access to low-cost funding from cooperatively owned banks.

In Germany, about half the total assets of the banking system are in the public sector, while another substantial chunk is in cooperative savings banks. Germany’s strong public banking system includes 11 regional public banks (Landesbanken) and thousands of municipally owned savings banks (Sparkassen). After the Second World War, it was the publicly owned Landesbanks that helped family-run provincial companies get a foothold in world markets. The Landesbanks are key tools of German industrial policy, specializing in loans to the Mittelstand, the small-to-medium size businesses that drive the country’s export engine.

Because of the Landesbanks, small firms in Germany have as much access to capital as large firms. Workers in the small business sector earn the same wages as those in big corporations, have the same skills and training, and are just as productive. In January 2011, the net value of Germany’s exports over its imports was 7 percent of GDP, the highest of any nation. But it hasn’t had to outsource its labor force to get that result. The average hourly compensation (wages plus benefits) of German manufacturing workers is $48—a full 50 percent more than the $32 hourly average for their American counterparts.

5. The Bank of North Dakota’s record is tarnished by its connection with fossil fuels.

This is a curious non sequitur. If Mr. Calabria intends to imply that the BND’s success hinges on the oil boom, Ellen Brown convincingly refuted that assumption in 2011 and again in 2014 (“the BND’s return on equity was up to 23.4% in 2009 – substantially higher than in any of the years of the oil boom that began in 2010”); if anything, the causal arrow goes in the other direction. If it’s a swipe at BND and North Dakota for propping up fossil fuels, that’s a curious argument considering that public banks could efficiently and quickly fund a transition to renewable energy. Under either interpretation, the success of the BND is in no way undercut by its support for North Dakota’s extraction infrastructure. Most of us at PBI (and we guess most of you) want a post-carbon economy. Public banks are a key way to get there.

6. North Dakota would have received more interest on its deposits with private banks.

Profitability from high interest is precisely what we are fighting against when the projects or businesses being financed are essential for the public good, and produce long-term growth that far exceeds the value of a bank's short-term profits. Mr. Calabria also fails to mention the dividends BND annually pays into the state, the benefits of BND’s disaster relief and emergency programs, or their ability to quickly create the infrastructure that facilitated North Dakota's oil boom.

For points 7 and 8 below, Mr. Calabria relies on a couple of studies that he says indict public banks. The problem is that the authors of the studies are explicit in defining “government” banks as quite distinct entities, definitions so specialized that the Harvard study doesn’t even include the Bank of North Dakota in its analysis—because the BND isn’t the kind of bank its authors are studying.  Indicting the Bank of North Dakota by using aggregated descriptions of “government banks” that, by definition, exclude the Bank of North Dakota is, to put it bluntly, intellectually dishonest.

7. Research concludes that “higher government ownership of banks is associated with slower subsequent development of the financial system.”

This is Calabria’s citation of the Harvard study, which is from 2002 and uses data from 1960-1995, long before 2008 and the collapse and bailout of the big banks, and also before the recent peak years of the BND’s performance. It is vital that readers wanting to compare research read the actual study, because it’s clear that it makes very few conclusions relevant to a discussion of whether states, cities, and counties should set up BND-style banks. In fact, because of the way the authors define “government-owned banks,” the study lists the United States as having no such banks—the BND is not listed. “We do not include Central Banks, Postal Banks (which generally do not lend money to firms and are described as nonbanking institutions), investment banks, other specialized financial intermediaries (trust companies, home loan banks) or worldwide development banks such as the World Bank,” the authors explain. This research doesn’t apply to the BND or the type of banks PBI and its allies envision.

8. Research concludes that “political interference with bank lending decisions generally results in worse economic outcomes.”

This is Calabria’s representation of a paper by Taiwanese professor of finance Chih-Yung Lin, of the National University of Taiwan, “Why Do Government Banks Perform Worse? A Political Interference View.” That paper’s author sets out to examine why government-owned (not BND-style) banks fail in developing countries, and the author clarifies that “government banks in developed countries escape relatively unscathed while those in developing countries suffer significantly.” The data supporting the general conclusion that “government banks” perform worse comes from “71 emerging economies.” The author repeatedly reminds readers that this is not true in developed countries. Again, in this study, a “government-owned bank” is not a BND-style public bank, but rather any bank where the government has a shareholding exceeding 20% of total shares.

Even if the data were applicable, the author is more open about his value assumptions than Calabria is. Chih-Yung Lin cites explanations such as “government banks are designed to maximize social welfare rather than profit,” according to the social agency view.  The research includes anecdotal factors such as the replacement of bank executives following presidential elections. The actual conclusion of the paper is that political interference, in the form of ideology-driven or party-driven replacement of bank personnel, undermines the financial performance of public banks. Of course, there is no evidence that the BND suffers from political interference with its decisions. Charters and legislation prevent such problems.

9. "Government-owned banks also tend to under-price risk in order to appeal to voters."

There is no contemporary or definitive evidence of this. The administrators of the BND would have no reason to do so. Nobody’s job depends on the outcome of a single election, and nobody’s political career in North Dakota would be made or broken because of BND.

Mr. Calabria’s research is old, doesn’t account for too-big-to-fail banks, doesn’t apply to the Bank of North Dakota’s century of success, distorts the research of others, and hastily reasons from insufficient and inapplicable examples. More recent research consistently reaches optimistic conclusions about publicly-owned banks. To use just one example, Ellen Brown’s 2015 compilation of research on Sparkassen is devastating to Cato’s arguments:

In January 2015, the SPFIC published a report drawn from Bundesbank data, showing that the Sparkassen not only have a return on capital that is several times greater than for the German private banking sector, but that they pay substantially more to local and federal governments in taxes. That makes them triply profitable: as revenue-generating assets for their government owners, as lucrative sources of taxes, and as a stable funding mechanism for small and medium-sized businesses (a funding mechanism sorely lacking in the US today).

Brown continues: “Swiss public banks, too, have been shown to be more profitable than their private counterparts” (citing yet another study). This research review is newer and more comprehensive. She cites Professor Kurt Von Mettenheim, who concluded in 2011 that public savings, cooperative, and public development banks outperform for-profit banks. Brown also points out the subjectivity of performance criteria: Western politicians call unpaid loans to public entities deficits, while China views the spending as productive. This is especially important when considering public projects or paying for policy implementation. Low-interest loans “produce more public policy for less cash,” according to Mettenheim and Olivier Butzbach. Stakeholders have different values than shareholders. Even if Calabria were reasoning correctly from his research (and we don’t think he is), he is reasoning from different fundamental values and definitions than we are.

Several people assisted in the writing of this article. Thanks to Scott Baker, Marc Armstrong, Ellen Brown, Walt McRee, Earl Staelin, and Douglas Alde. Any errors, however, are solely my own.