Once in a while, you’ll see stories pop up about state governments looking into setting up a state bank, Washington being the latest sighting, along the lines of the only state bank in the US, the Bank of North Dakota. And there’s good reason. The Bank of North Dakota has an enviable track record, having remained profitable during the credit crisis. Moreover, in the ten years prior, the bank returned roughly half its profits, or roughly a third of a billion dollars, to the state government. That is a substantial amount in a state with only 600,000 people. The bank was also able to pay a special dividend to the state the last time it was on the verge of having a budget deficit, during the dot-bomb era, thus keeping state finances in the black.
But the good financial performance is simply an important side benefit. The bank’s real raison d’etre is to assist the local economy. And it has done so for a very long time. It was established in 1919 as part of a multi-pronged effort by farmers to wield more power against entrenched interests in the East.
And the most important potential use of this type of bank in our era could again be to level the playing field with powerful interests, in this case, the TBTF banks.
On the funding side, the Bank of North Dakota is the depositary for state taxes and fees. Its president described its role to MotherJones last year:
The interesting thing about the bank is we understand that we walk a fine line between competing and partnering with the private sector. We were designed and set up to partner with them and not compete with them. So most of the lending that we do is participatory in nature. It’s originated by a local bank and we come in and participate in the loan and use some of our programs to share risk, buy down the interest rate. We even provide guarantees similar to SBA to encourage certain activity for entrepreneurial startups. Aside from that, we also act as a bankers’ bank or a wholesale bank. So we provide services to banks, whether it’s check clearing, liquidity, or bond accounting safekeeping. There’s probably 20 other bankers’ banks across the country. So we act in that capacity as kind of a little mini-fed actually. And so we service 104 banks and provide liquidity to them and clear their checks and also we buy loans from them when they have a need to overline, whether it’s beyond their legal lending limit or they just want to share risk, we’ll do that. We’re a secondary market for residential loans, so we have a portfolio of $500 to $600 million of residential loans that we buy….
We’re a fairly conservative lot up here in the upper Midwest and we didn’t do any subprime lending and we have the ability to get into the derivatives markets and put on swaps and callers and caps and credit default swaps and just chose not to do it, really chose a Warren Buffett mentality—if we don’t understand it, we’re not going to jump into it. And so we’ve avoided all those pitfalls. That’s not to say that we’re completely immune to everything, certainly we’ve bought some mortgage-backed securities and we’re working through some of those issues, but nothing that would cause us to be concerned.
Now why would this model make sense? As we’ve stressed here, community knowledge has tremendous value in banking, and even though we can’t prove it, we suspect this is the biggest single reason that large banks are less profitable (yes, you read that right) in terms of assets than smaller banks. Reliance on scoring systems is no substitute for having local intelligence and, for larger loans, in person assessment. And a state bank is under none of the growth pressures that private banks face, which lead them to overextend in supposed good time and leave themselves and those around them with major hangovers.
Moreover, the state bank also serves as a mini central bank, providing overnight funding. It may also thus help to lower smaller banks’ funding costs and make them more competitive.
Now admittedly, the Bank of North Dakota’s success depends on being stodgy. One can easily imagine a state bank being pressured to become more “profitable” to help out the state budget, with it winding up taking riskier bets and suffering the same eventual bad outcomes as private sector banks.
But consider another very useful a state bank could play (although existing in state banks would fight it tooth and nail). The Bank of North Dakota is a wholesale bank, so the lack of the costly retail branch infrastructure is one of the reasons its results are as good as they are.
But another role a state bank could play would be to apply pressure to banks in that state. For instance, one of the most important planks lost in the Consumer Financial Protection Bureau was the requirement that banks offer “plain vanilla” products, such as a simple mortgage and a low fee, low interest credit card.
In states where the TBTF banks are not very well liked and not as influential (which generally means states west of the Mississippi which lack major bank headquarters or regional operations, like Citibank’s credit card processing center in South Dakota), a state bank could serve as a wholesaler of plain vanilla products to smaller banks (or alternatively help fund a common platform to scale up existing plain vanilla products offered by credit unions so as to make them more economically attractive to other banks in state). There is no question the consumer demand exists; the trick is how to make the product for smaller banks, who would not doubt separately find it a good hook for attracting deposits from bigger banks.
I find the state bank concept intriguing, because it has the potential to operate in bank-as-utility mode, which is really all banks ought to be. And in that mode, they could apply a lot of useful pressure on nominally private banks which pay their staff and top brass handsome pay at taxpayer expense.
Before readers argue that this is tantamount to socialism, that would be better than what we have now. As we noted in an earlier post “Why Do We Keep Indulging the Fiction That Banks Are Private Enterprises?“:
Big finance has an unlimited credit line with governments around the globe. “Most subsidized industry in the world” is inadequate to describe this relationship. Banks are now in the permanent role of looters, as described in the classic Akerlof/Romer paper. They run highly leveraged operations, extract compensation based on questionable accounting and officially-subsidized risk-taking, and dump their losses on the public at large.
But the subsidies go beyond that. To list only a few examples: we have near zero interest rates, which allow bank to earn risk free profits simply by borrowing short and buying longer-dated Treasuries. We have the IRS refusing to look into violations of REMIC rules, which govern mortgage securitizations. We have massive intervention to prop up real estate prices, with the main objective to shore up banks; any impact on consumers is an afterthought.
The usual narrative, “privatized gains and socialized losses” is insufficient to describe the dynamic at work. The banking industry falsely depicts markets, and by extension, its incumbents as a bastion of capitalism. The blatant manipulations of the equity markets shows that financial activity, which used to be recognized as valuable because it supported commercial activity, is whenever possible being subverted to industry rent-seeking. And worse, these activities are state supported.
Consider Fannie and Freddie pre-conservatorship. They were at least branded more accurately as “government sponsored enterprises” and “agencies” making their public/private role explicit. Yet they were over time allowed more and more latitude to act as private enterprises, particularly as far as employee pay was concerned. We know how that movie ended…
So, the reality is that banks can no longer meaningfully be called private enterprises, yet no one in the media will challenge this fiction. And pointing out in a more direct manner that banks should not be considered capitalist ventures would also penetrate the dubious defenses of their need for lavish pay. Why should government-backed businesses run hedge funds or engage in high risk trading, or for that matter, be permitted to offer lucrative products that are valuable because they allow customers to engage in questionable activities, like regulatory arbitrage? The sort of markets that serve a public purpose should be reasonably efficient and transparent, which implies low margins for intermediaries.
Right now, we have much of the banking sector operating so as to privatize gains and socialize losses. We might as well socialize the gains, as North Dakota does. Even if this idea took hold in only a handful of states, the trend could lead to a change in the perception that big financial interests always and ever have the upper hand and thus lead to a change in the negotiating dynamics in policy and regulatory circles.