Time for a Third Bank of the U.S.?

March 20, 2009 7:38 AM

Why do we not have a government owned national bank that competes with private banks?

I'm a layperson, and in these past few months I've learned more than I wanted about macroeconomics. I understand the basics of: mortgage-backed securities, credit default swaps, and the Commercial Paper market. I understand how you can't have an economy without banks. The freezing of credit is stalling the economy, no one wants to lend money due to fear of banks going under, and that the banks are all tied together. The U.S. is paying (via more debt to taxpayers) for bad assets or buying stakes in the banks. It's difficult to nationalize all the banks and then re-privatize them, because who's around to buy all the banks?

Why is the banking system not considered like a public good that should not be solely in the hands of private enterprise? If you don't like driving the Interstate from NY to CA, take a plane. But, if the airlines go bankrupt or shut down (i.e. after 9/11), then you can still get to where you need to go. Public schools vs. private schools, Social Security vs. 401k, Medicare vs. private health insurance, are further examples of public services competing with private services. So, if companies cannot borrow money from banks to keep operating, due to banks being insolvent/illiquid/snafued or whatever, then why can't businesses turn to the government for direct loans? Why is there not a national bank like we had in the past? What are the arguments against it?

Be kind, I'm all befuzzled and trying to learn.

posted by medarby to law & government (24 comments total)

how you can't have an economy without banks

Douglas Rushkof begs to differ [on the blue here] and presents some interesting (if slighly idealistic) ideas.
posted by namewithoutwords at 8:04 AM on March 20

For-profit banks only lend money to companies and individuals who will use the proceeds productively and pay the funds back with interest (in theory, anyway). This makes banks a mechanism for ensuring the efficient allocation of capital. A government institution would have all sorts of conflicting mandates and would make this process inefficient.

Fannie and Freddie are good cautionary examples. There were good intentions behind their formation and mission, but their quasi-government status really mucked up the system.

It's difficult to nationalize all the banks and then re-privatize them, because who's around to buy all the banks?

I think you underestimate the market for a recapitalized bank with a clean balance sheet. Such an institution would be very profitable in this environment. The IPO wouldn't be easy, but I don't think it's worth dismissing. Also, this is a radical idea, but we could just distributed exchange-listed shares to the taxpayers (see point #3 in the link) rather than sell the shares on the market. Some people could hold the shares, while others could sell them immediately on the secondary market.
posted by mullacc at 8:21 AM on March 20

Also a large government bank could fail just as easily as a for-profit bank. In fact given the cesspit of corruption public banks have historically been its more likely to collapse then a private bank.
posted by JPD at 8:43 AM on March 20

A government institution would have all sorts of conflicting mandates and would make this process inefficient.I understand government in general is less efficient than what private enterprises could/would do. But, when it comes to basic services (e.g. transportation, health care, education), I'd argue government has a job to compete with private enterprises, if nothing else as a safety net. I'd also argue that the banking system is a basic service in any economy. Also, government is the safety net for the banking system right now. So why shouldn't it have a more direct role and offer an alternative (not a replacement) to private banks, instead of propping up insolvent banks?
posted by medarby at 9:22 AM on March 20

I'd argue government has a job to compete with private enterprises, if nothing else as a safety net.

Thats your personal bias and personal ideology. In the US both conservatives and moderate Democrats disagree with you and they make up the majority of the votes in congress, thus no national bank. You can make good arguments until you are blue in the face, but its a minority opinion in the US.
posted by damn dirty ape at 9:37 AM on March 20

I understand government in general is less efficient than what private enterprises could/would do. But, when it comes to basic services (e.g. transportation, health care, education), I'd argue government has a job to compete with private enterprises, if nothing else as a safety net.

I think we're using different concepts of "efficiency."

With health care, education and similar social services, we don't have to make decisions about who gets services. Ideally, everyone should get those things. If we can't afford that, we give it to the most needy. Efficiency is about delivering services reliably and affordably.

A bank that lends to commercial enterprises needs to pick winners and losers. Efficiency in this case is about allocating capital to its best use. How should a government-run bank make such distinctions? How can it avoid politicization of this process? State-owned banks still exist, of course, but they all face this problem and have dealt with it in various ways.

Also, banking is already a heavily regulated industry. There are all sorts of rules about capital standards, fair lending and appropriate business activity. There's the FDIC protection for depositors and the Fed for maintenance of rates, reserves and overnight lending. Essentially, the government has already guaranteed continuity of service for essential banking activity. You may to move your business from one bank to another, but that's not a huge deal. There is still the risk of systemic bank failure/insolvency, but as JPD mentioned, a state-run back would face that risk just like private banks do now.
posted by mullacc at 9:45 AM on March 20

Way to contribute dirty ape. Thanks for enlightening me on that...

My question is, what is the economic reasons why not? I'm not looking for ideology or bias, I'm looking for an economic lesson here. I understand in practice there is corruption, waste and politics in any government enterprise. That's government. But if that's the case, why have government in any of these enterprises? Any of those services I've mentioned are also heavily regulated and subject to failure, waste, and politics. Turn it on it's head: what's the economic reason to HAVE government in highways, education and health insurance? Why are those economic arguments NOT applicable the banking system? Should not everyone get/have access to banking services?
posted by medarby at 10:21 AM on March 20

mullacc, you're link isn't working.
posted by medarby at 10:23 AM on March 20

Sorry, here's the link to the Interfluidity post (see point #3).

I understand in practice there is corruption, waste and politics in any government enterprise. That's government. But if that's the case, why have government in any of these enterprises?

I think I addressed this point in my last post, but in summary here's my reaction:

Because the government can still deliver "highways, education and health insurance" even with the corruption, waste and politics.

It cannot run a useful bank under those same conditions. To the extent it could provide some guarantee of bank services, it already does (FDIC protection, regulation, the Fed).
posted by mullacc at 10:28 AM on March 20

There is much more societal benefit to highways, education and health care being delivered with an implicit government subsidy then there would be to government subsidized banking. Think about the mechanism of how a bank makes money as opposed to how a toll road makes money?
posted by JPD at 10:42 AM on March 20

mullacc, I understand. Why not? What is is about private that makes them immune to corruption, waste and politics? It certainly looks like they're not immune to me. So why is banking sacrosanct and only entrusted to private entities?

I'm not hearing economic reasons why government should not operate a bank as an alternative to private banks. "It's not efficient" is a reason, but doesn't explain why then is government in those other areas. If Thomas the Tank Engine can't get credit to merge with another business due to credit markets seizing up, why can't they go to the government DIRECTLY for the loan? Businesses are getting loans indirectly from the government through TARP and stock injection plans so banks can lend, so why not directly and cut out the middle man?
posted by medarby at 10:56 AM on March 20

interesting article, namewithoutwords. I especially like the statement "Using future tax dollars to give banks more money to lend out at interest is robbing from the poor to pay the rich to rob from the poor."
posted by medarby at 11:30 AM on March 20

What is is about private that makes them immune to corruption, waste and politics?

The profit motive. Maybe it seems quaint now, but many of us still think that if you run a company honestly and cautiously, it'll be more profitable over the long run than if you loot it and your customers.

Furthermore, the profit motive simplifies things. If we can minimize corruption and waste, the profit motive will guide bank managers to make the most profitable decision, which will be to lend to the best borrowers. If we can minimize corruption and waste in government, we still have the problem of deciding how to manage the bank. With limited capital, how do you decide between two different borrowers? Some will say give the capital to the party that will pay more, but certainly others will have different priorities. And what happens when borrowers default? Does the bank have the political will to foreclose and liquidate businesses? These are complicated decisions and I'm not sure we have the right system in place to make them.

It certainly looks like they're not immune to me.

To come to this conclusion, I think you need to determine whether or not banks do a good job lending money.

To that point, you have to determine if the current crisis was caused by either bad lending decisions, bad funding decisions or some mix of both. There's a case to be made that banks were doing okay picking out borrowers for the most part, but they did a poor job structuring their own balance sheets to withstand inevitable mistakes and economic downturns. Certainly lending standards were way too loose, but those problems were magnified by the banks' over-leveraged balance sheets. It wouldn't be unreasonable to come to the conclusion that banks still do a decent job lending money, but need to be regulated on the funding side to keep systemic risks at bay.

And clearly there is a need for more and/or smarter regulation of banks and financial institutions. Hopefully that can be done without giving up the benefit of private enterprise.

If Thomas the Tank Engine can't get credit to merge with another business due to credit markets seizing up, why can't they go to the government DIRECTLY for the loan?

That article says nothing about the financial condition of this company. Just because it's a recognizable brand does not mean it was a good credit risk. Perhaps it was not a prudent deal. I know for a fact that $163MM deals can and have been done recently, but we're in an economic downturn so the hurdles are higher. Those higher hurdles are most likely more prudent and less risky than the low standards of the last few years. If that Thomas the Tank Engine deal couldn't get done, it's because it required cheap funding and high leverage to make it profitable.
posted by mullacc at 11:33 AM on March 20

Was not the current crisis triggered by the sub-prime mortgage mess (bad lending), and spread by speculation in the unregulated credit default swap market (bad funding)? Banks are in trouble because their balance sheets are out of whack; government is trying to restore it.

mullacc, I appreciate you keeping up with me. I understand your basic point is that governmental politics would make bad decisions. But I still say that's a valid point for any governmental enterprise. Why is banking, and not the other areas, hands-off for government provided direct services, when it's ultimately on the hook?
posted by medarby at 12:27 PM on March 20

Was not the current crisis triggered by the sub-prime mortgage mess (bad lending)

Absolutely. The sub prime bubble was clearly an example of bad lending. Does it prove that banks are bad at mortgage lending? Arguably, but my opinion is that this was a problem generated by bad funding decisions. Banks have good mortgage underwriting in place, but they ignored those standards because they could sell into the securitization market and hedge risks via the CDS market. If the funding side had been restrained, I don't think the lending standards would have been blown out of the water.

Sometimes the market turns irrational, but those examples don't necessarily mean that private bank lending isn't the best system over time.

Why is banking, and not the other areas, hands-off for government provided direct services, when it's ultimately on the hook?

Well, if you don't buy my argument that efficient banking requires the profit motive, then we'll have to agree to disagree. To be clear, I'm not a free market fundamentalist--I strongly support universal health care, for example.
posted by mullacc at 12:47 PM on March 20

I do buy your argument that efficient banking requires the profit motive. I understand that. But my point is, I'm sure the other areas that government is in are more inefficient that their private counterparts (USPS vs. UPS for example, or Interstate Highways vs. airlines), yet they are arguably the direct safety net for those areas (package delivery and transportation) that are immediately available if and when their private counterparties fail. Why is there not a direct safety net for basic banking functions from the government that exists separately from private banks? Why do we have to go through these complicated process to prop up insolvent banks? IMO, it's like not having the USPS and the government propping up UPS and FedEx.

It may not seem so, but I'm truly curious and trying to learn the economic arguments, not making political judgments. Thanks again in advance.
posted by medarby at 4:00 PM on March 20

The safety net you speak of is theoretically best implemented through apolitical regulation and deposit guarantees. Has all of the upside of a public bank w/o distorting the market, allows innovative well-run banks to thrive, allows bad banks to fail. Prevents the creation of massively inefficient public banks that waste government capital that could be better invested elsewhere. The reason why it is better invested elsewhere is that cheap banking isn't as important to society in the long run as affordable healthcare, education, and transportation - there is a whole different conversation about why the state should have a role there that isn't really germane to your question - other then to say the analogy you keep reaching back towards is probably no great.

What the the entire world messed up (its naive to say it was just the US - there is a reason why AIGFP was based in London, or that half of Austria and Italy's banks are on the brink because the regulated there failed to spot something incredibly obviously stupid they were doing in the name of grander political goals) is they relaxed regulation and allowed banks to grow to massive sizes - predicated on the naive belief that the banks were smart enough not to blow themselves up. The failed to realize that the compensation regimes in place distorted the risk/reward balance in a way that doomed it all to failure.
posted by JPD at 4:21 PM on March 20

In your two examples the government entity/activity exists to provide a function that couldn't be undertaken profitably in the private sector. Delivery of mail to just about any rural address in the country, for example. Or the the construction and maintenance of thousands of miles of highways across the western states.

The US government isn't running farms even though our food supply chain is more important than our banking system. However, it does regulate the industry and would probably bail it out if it were on the brink of collapse. But in the meantime, the preference is to let the private sector conduct most activity.

In the case of banking, the safeguards didn't work because the regulators were undermined or short-sighted. That justifies regulatory reform, but it doesn't mean we need to usher in a public bank.
posted by mullacc at 4:55 PM on March 20

Also, I'm not sure you realize the extent of the banking safety net and/or direct services already provided by the US government. For example, the Small Business Administration (and within that, the SBIC), the Export-Import Bank and the Federal Home Loan Bank system.
posted by mullacc at 5:01 PM on March 20

Just because it's government owned doesn't necessarily mean it's not-for-profit. You could have a govt owned bank which is run for a profit and pays managers a percentage of gains.

One big problem with a govt bank is that it can borrow cheaper than anyone else so it can always lend at a better rate and/or make a higher spread. Govt prints money and can tax--so I'm pretty darn likely to get paid back when I lend to the govt. If I lend to a private bank, there's a chance they go out of business, leaving me unpaid. FDIC insurance levels the playing field for deposits, but there's just no comparison for longer term funding (and since the govt could pull FDIC insurance from any bank or cancel the program, it's still not as good). So unlike roads or schools, the fact that the govt is in the business keeps the private sector out of the business.

The other problem is corruption. And it's a problem in all aspects of govt, but in banking it's much more difficult to identify. Building a road, there's a high bid and a low bid and minimum specs for the road. In banking, if two people come in for a loan, it's much more subjective. Which business plan is "better" and more deserving of a loan? There's a big risk that cheap loans will be steered to political allies.
posted by limagringo at 5:42 PM on March 20

The First and Second Banks of the United States weren't such great successes, and I really do think that's part of the issue. Perhaps Thomas Jefferson was right in the first place.

Changing the paradigm from the current "there is no central bank, but there's this giant Federal safety net" would be enormously hard work, and it's hard to see how it could happen.
posted by Sidhedevil at 6:01 PM on March 20

A bank that lends to commercial enterprises needs to pick winners and losers. Efficiency in this case is about allocating capital to its best use. How should a government-run bank make such distinctions? How can it avoid politicization of this process? State-owned banks still exist, of course, but they all face this problem and have dealt with it in various ways.

One issue is whether government owned banks need to make the distinction and the role of the banks within society. State owned banks in Germany exist not just as sources of capital but also as tool of German industrial policy. State ownership of the banks allows the German government to direct funds to assist alongside policy initiatives and help to establish new industries. While an argument can be made that this is less efficient, if the new domestic industries come to fruition then they can become internationally competitive and Germany wins through enhanced export opportunities alongside social benefits linked to increased eomployment opportunities. Of course, if they don't then the money is lost.
posted by biffa at 1:33 PM on March 21

Thanks for all your responses. I've got a lot to learn.

The references to the international situation is intriguing. I had heard a little, but the most of the focus of the news I've read was on domestic issues. Does anyone know how the credit markets are doing in other countries that have government banks versus those that don't? Can businesses still operate and have access to capital like before the crisis?
posted by medarby at 5:54 PM on March 21

Does anyone know how the credit markets are doing in other countries that have government banks versus those that don't?

Take a look at what has happened to the French Mutuals for example, or the German system where several of the banks controlled by the Lander have run into trouble. Of course the Landesbanks have always been problematic (how do you know its the top of the cycle? Because you just heard a Landesbank is hiring people in NY to get into the business)

Postbanks have generally been fine - but they don't play a big role in financing businesses.

Everyone is having trouble. It seems as though the US's banking issues have peaked, whereas there is more bad news to come in much of the rest of the world.
posted by JPD at 4:08 AM on March 25