By Karen Petrou
In a blog post this summer, we assessed the history of U.S. public banks over three centuries. We concluded that, “The best way to ensure that financial intermediation advances social welfare is to define a carefully-constrained charter, mandate transparent limits on self-dealing up front, and ensure that the bank is fit for purpose under reasonable rules that ensure long-term profit in concert with effective public service. Public subsidies to support public service make sense, but only when sufficient regulation and private-sector discipline constrain the natural self-serving instincts of all-too-many politicians.” Maybe so, but sizeable minorities of voters this November said that they so distrust private banks that they want a public alternative no matter the controls that might apply. In a blue-wave mood, federal legislators are listening.
In this update, we review several federal public-bank constructs. We also reiterate the benefits of back-end federal guarantees as an alternative and in our view better way to align the discipline of private profit with innovative, equality-enhancing financial products.
The Biggest Public Bank of All
Is a federal public bank an outlandish political prospect? Not if it’s the Fed, it isn’t. As we noted earlier this year, Switzerland – a country one would never have thought even slightly inclined to state-sponsored banking – came seriously close to approving the “Vollgeld” initiative to create one. Inspired thereby, a think tank affiliated with Sen. Warren (D-MA) developed a construct in which the Federal Reserve takes retail and small-business deposits that are then lent by the Fed to banks that pass the money back into the economy. Our earlier blog post describes the sizeable monetary-policy and equality problems with this construct.
Is a federal public bank through the Fed impossible? One might think so, but it’s worth noting that the Fed on its own has quietly nationalized large swaths of the U.S. payment system. It is now proposing to expand its reach as the owner/operator of the important and overdue U.S. faster payment system. A good deal of research concludes that faster payments will only work as needed if the plumbing comes attached to attractive value-added products. If the Fed takes over faster payments, could it resist the temptations of more direct engagement in the retail finance system? Mission creep is ever-present in government-sponsored activities with full-faith-and-credit backstops and no third-party governance.
Additional Public-Bank Options
The biggest near-term battle over public banks will come as Congress and the White House decide next year what to do with two failed guarantee programs embodied in the GSE conservatorships. Another will come as Democrats push President Trump to create the Infrastructure Bank proposed in the Obama Administration. Yet a third will arise as progressive Democrats, including several Presidential hopefuls, renew calls for a U.S. postal bank. On December 4, an Administration postal-services task force unsurprisingly opposed a USPS postal bank. We think one has some pluses and more than a few minuses, but it’s also more than unlikely.
Progressive Democrats are also readying a “Green New Deal” likely to include a federal “Green Bank.” Several states have established Green Banks and, despite their mixed records, climate-change advocates are turning to this construct as a key plank in a federal action plan. Administration opposition here is also a virtual certainty.
What Might Work
The more usual way the U.S. channels private capital to public goals is via a federal guarantee. These guarantees have a very mixed record. It comes not only from mission creep in which the federal government edges out private providers, but also from inevitable political temptations to craft guarantees for the benefit of contributors, not the public at large. Been there, done a whole lot of that in the housing-finance sector, not to mention many agriculture and energy guarantee programs, crop insurance, and other guarantees with dubious social-welfare benefits.
Even so, we think carefully-designed guarantees efficiently achieve social welfare at minimal taxpayer cost when and if terms and conditions are aligned to prevent moral hazard and fiscal-policy arbitrage. We thus worked hard to ensure appropriate disciplines in the one social-welfare guarantee we crafted: legislation (H.R. 6421) to create an “Eye Bond” program to speed treatments and cures for blindness by way of a limited federal guarantee backing new-entry institutional investment in biomedical research.
Our goal, ambitious though it is, is not only to cure many forms of blindness far more quickly than might otherwise occur, but also to craft a new class of social lending – we call them Bio Bonds – that expedite treatment and cures across a range of diseases and disabilities. Private banks would do the lending and institutional investors would buy the bonds, with all of this capital flowing to end suffering in ways simply not possible – at least not now – without a federal guarantee.
How do we solve for political self-interest, institutional self-dealing, and taxpayer risk? In sharp contrast to the problematic guarantee programs described above, taxpayers – not lenders or investors – would be paid off first as loan obligations are met. A good guarantee isn’t a 100% money-back guarantee; it’s a cushion that alters regulatory incentives, reassures fiduciary-duty concerns, and paves the way to a new, wholly private market.
Why not a Bio Bank?
In a prior post and other work, we’ve outlined an “Equality Bank” to marshal private capital to dedicated equality-enhancing purposes. It’s just as possible, at least in theory, to create a Bio Bank or, for that matter, any of the public-bank charters such as a green or infrastructure bank. The difference in our view is where first-loss tranches land. When private capital is upfront or, even better, on its own, then incentive alignment enhances prudent activity; when the taxpayer takes it on the chin, not so much.