Martha R wrote to tell me that a serious effort is underway in Vermont to launch a state bank. 20 towns will be voting on town meeting resolutions to establish a home-grown, public bank. The objective is not to set up a retail bank (say along the lines of a Post Office bank) but to save the fees that are now paid to large financial institutions and to fund public projects. She writes:
Town meetings cannot make it happen but they serve as a litmus test of existing political will and they send a message to state government that is heeded. There’s already a bill in the state senate.
As readers may know, the one state bank in existence, that of North Dakota, has been a success. As we wrote in 2011:
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.
The Bank of North Dakota serves as a repository for state taxes and fees. It does not originate loans but will chose to participate in loans that local banks bring to it. It also acts as a mini-central bank and provides overnight funding to in-state banks.
The idea for the Vermont bank is a tad more ambitious, since it would build on an existing, well-run non-profit public agency that provides loans, the Vermont Economic Development Authority. The state Senate bill proposes having VEDA obtain a banking license and take 10% of state deposits. Supporters hope that as the state bank gains experience, it would eventually hold all state funds, which are mainly now with TD Bank.
An article in Vermont Public Radio describes the issues raised against it. One of the nay-sayers is the state Treasurer, Beth Pearce, argues that a state bank would not be efficient. Vermont’s cash balances range from $20 million to $300 million over the course of a year. However, I’m not convinced. Every study of bank efficiency has found that banks show increasing cost curves (as in their costs rise as total assets grow) with the break point occurring as low as around $1 billion to as high as $25 billion (ironically, I’ve had difficulty finding any studies since the early 2000s, no doubt because the finding were contrary to the myth that bigger banks are more efficient). And a state bank would not have a costly branch network or individual account/transaction processing, which means it would be efficient at a lower level of activity than a conventional bank.
The biggest potential fly in the ointment is that the ratings agencies may take a dim view of a state bank. As the article explains:
She [Pearce] says if Vermont’s relatively small cash assets were in a state bank that money would be at greater risk; for example if loans go bad.
And if the big credit rating agencies see a public bank as risky, it jeopardizes Vermont’s bond rating.
Pearce says that’s important because a lower bond rating makes it more expensive for the state and lending agencies to borrow money.
A poor bond rating “turns around and affects every Vermonter.” Pearce says. “Whether it’s affordable housing, whether it’s a college education for students, commercial development in the state, commercial energy improvements in the state. Those are the types of things that benefit from our bond rating. I don’t want to put that at risk.”
Public bank supporters say the risk is overstated. They point to VEDA’s success and its high loan repayment record. Gary Flomenhoft [author of a study on state banking] argues that state money in large institutions like TD Bank is also at risk.
Unfortunately, the risk that the ratings agencies will take a dim view is real, because they often act as enforcers for major financial players. As Matt Stoller wrote in 2011:
In the early 2000s, several states attempted to rein in an increasingly obvious predatory mortgage lending wave. These laws, pushed by consumer advocates, would have threatened the highly profitable mortgage securitization pipeline.
S&P used its power to destroy this threat. Josh Rosner and Gretchen Morgenson told the story in Reckless Endangerment.
Standard & Poor’s was the most aggressive of the three agencies, however. And on January 16, 2003, four days after the Georgia General Assembly convened, it dropped a bombshell. Because of the state’s new Fair Lending Act, S&P said that it would no longer allow mortgage loans originated in Georgia to be placed in mortgage securities that it rated. Moody’s and Fitch soon followed with similar warnings.
It was a critical blow. S&P’s move meant Georgia lenders would have no access to the securitization money machine; they would either have to keep the loans they made on their own books, or sell them one by one to other institutions. In turn, they made it clear to the public that there would be fewer mortgages funded, dashing “the dream” of homeownership.
Can you see the topsy-turvy reasoning? Because Georgia proposed to hold lenders and investors in securitizations accountable for predatory loans, S&P said these higher-quality loans were ineligible to be included in mortgage pools. Why? Because, in the presumably smaller percentage that did wind up being predatory anyhow, the state could seek recourse from lenders. That arguably might lower cash flows to investors. Can’t have investors be responsible for their decisions, now can we?
And S&P’s press release made clear it intended to kill any similar rules in other states:
It ended with a warning: “Standard & Poor’s will continue to monitor this and other pending predatory lending legislation.” In other words, any states that might have been considering strengthening their predatory lending laws as Georgia did should beware.
That press release is here. S&P was aggressively killing mortgage servicing regulation and rules to prevent fraudulent or predatory mortgage lending.
The third risk, which overlaps with the second, is that of geographic concentration. But I’d hazard the bigger real risk is cronyism. North Dakota is the one survivor of seven state banks that were established. The fundamental reason it performed well and the others didn’t was the others were subject to greater and lesser degrees of corruption. By contrast, the North Dakota state bank prides itself on its conservatism. The good track record of the VEDA and the high degree of civic engagement in Vermont says the bank has decent odds of escaping this pitfall.
But will the state risk incurring the wrath of the rating agency hit men? Stay tuned…..