Have you ever been at the local branch of your bank and thought “I wish this was more like being at the DMV?” If you somehow answered “yes” to that question, then the concept of public banking may be for you.
Legislators in states like Oregon and New Mexico have proposed legislation to allow state and local governments to create and operate public banks. At the federal level, Reps. Alexandria Ocasio-Cortez and Rashida Tlaib have introduced legislation intended to incentivize the creation of these publicly-operated banks through grants.
The logic behind public banking is that, “freed” of the profit motive, public banks can offer loans at lower interest rates and to a broader array of potential recipients. In the cbanksongresswomen’s minds, that would work to expand opportunities for entrepreneurship and access to capital.
Unfortunately, the reality of how such a system would function is far less rosy. The very profit motive that is supposedly holding back private banks from serving their communities is the reason why public banks could prove disastrous.
After all, implicit in the idea that public banks would expand access to capital is the idea that these potential new recipients can’t access it from private banks. The reason why this is the case is, of course, that these recipients would be risky loan recipients. Smart private banks know better than to extend risky loans without high interest rates — a public bank could well be forced to do so in the name of a misguided effort at addressing economic inequalities, adding even more burdens on taxpayers that are struggling in the wake of COVID-19 already.
It is far too early to have forgotten the lessons of the 2008 mortgage crisis. One reason why banks engaged in subprime loans is because of long-running efforts by the federal government to encourage writing mortgages for more and more people, without sufficient regard to their ability to pay. Now, just over a decade later, public banking advocates are essentially making a concerted effort for more subprime loans, only this time with taxpayer backing as an explicit (rather than implicit) guarantee.
Now, if you thought taxpayers were hung out to dry when the federal government paid out hundreds of billions in loans to bail out Wall Street (funds that were eventually paid back with interest), wait until you, the taxpayer, are directly on the hook for bailing out your state government’s public bank. Compared to having to pay back your state government for every dollar its bank lost, the Wall Street bailout looks like a clever investment.
Public banking advocates may well argue that this would not be the first time a public banking program has been tried. They’d be right, but it doesn’t work in their favor. Germany, for example, maintains public banks, but these same public banks were responsible for much of the losses from subprime mortgages in 2008, despite representing a minority of the German banking system. Rather than being evidence that the system works, the German example is evidence that public banks issue risky loans.
And indeed, study after study has come to the same conclusion — public banks simply do not manage their resources as well as private banks. One comprehensive survey by top economists found that greater government ownership of the banking system correlates with lower per capita income growth and lower productivity growth (a major factor in wage growth).
As with many progressive “innovations,” this cure could be far worse than the disease it aims to solve. Not only would consumers and businesses suffer from poorly-directed banking investments, but so too would taxpayers be on the hook for politically-motivated subprime loans. Taxpayers should be sure to tell their legislators to stay well away from public banking schemes.
Andrew Wilford is a policy analyst with the National Taxpayers Union Foundation, a nonprofit dedicated to tax policy research and education at all levels of government.