Banking on Colorado Response to
Calabria: Colorado would be wise to reject state-owned banking

Earl Staelin, board member of Be The Change — USA, and a leader in its initiative to establish public banks in Colorado, Banking On Colorado, wrote an Op-Ed for the Denver Post, entitled Colorado needs a public bank, which appeared in the print edition of the Denver Post on Sunday, February 15, 2015. In response to that Op-Ed, Mark A. Calabria, of the conservative think tank, the CATO Institute, wrote the following Op-Ed, appearing in the Thursday, March 5, 2015 print edition of the Denver Post — rebutting Mr. Staelins Op-Ed.

You will see as you read this piece that Mr. Calabria is either inaccurate in his statement of facts or he so cherry-picks them to support his opinion that this is not a credible rebuttal. We discuss here the problems with this Op-Ed paragraph-by-paragraph.

From the Denver Post (with our comments, clarifications, and corrections):


Colorado would be wise to reject state-owned banking
With Commentary from Banking on Colorado

By Mark Calabria

POSTED:   03/04/2015 02:59:02 PM MST   |   UPDATED:   03/04/2015 03:43:15 PM

The financial crisis and its associated rescues have left many of us, including myself, angry at our nation’s largest banks. The bailouts were unfair, with one set of rules for Wall Street and another set for Main Street. This understandable frustration has led some to believe the solution can be found in a state-owned bank. While we must search for a sustainable solution to the current flaws in our financial system, creating a state-run bank is a cure worse than the disease.

Like any good ideologue, Mr. Calabria, states his belief upfront — that “creating a state-run bank is a cure worse than the disease,” and goes on to either misstate facts, or so cherry-picks them that he cannot fail to support his belief.

Public banks have a long history, with the first known public bank established in Genoa, Italy in 1408. Its mission statement could have been taken from Occupy Wall Street, with one of its purposes “…to eradicate certain bad practices of bankers, who are so devoted to their own interest that they barely blush as they ruin the public good.” Like many public banks that followed, Genoa’s Banco di San Giorgio later failed in part due to its loans to government.

The first public bank was actually founded in Barcelona in 1401, the Taula de la Ciutat, to act as the treasury of the government of Catalonia. Others were established in Italy not long thereafter, including Genoa’s Banco di San Giorgio, established in 1408. Calabria provides no documentation or analysis for his conclusion that the bank failed in part due to its loans to government. This is a nice piece of history, but perhaps it’s best to focus, as he does, on banks that were established less than 200 years ago.

More recently the first American public bank was established in Vermont in 1806. It failed six years later, costing the citizens of Vermont the equivalent of almost $3 billion in today’s dollars. Seven other states established public banks in the 1800s, with the last of these, the Bank of the State of Alabama, failing in 1845. These banks were characterized by rampant corruption. As South Carolina legislator John Felder reflected in 1846, “Whenever … such cohabitation exists, the bank runs into politics and politicians run into the bank and foul disease and corruption ensue … .”

Looking at state banks formed in the early 19th century does have some relevance. However, these failures have only slightly more significance today than the Italian example given in the previous paragraph. Both the economic and political times were quite different. And the monetary system was very different when precious metal was involved. Further, democracies were young and inexperienced. States were still learning how to run democratic governments effectively. And many of the failures were due to faulty legislation that established the bank initially.

The Vermont State Bank proved successful, showing significant and increasing profits every year between 1807 and 1811 despite the many impediments thrown at Vermont by neighboring states and their private banks. In the words of Governor Galusha in 1809 in his message to the Vermont State House, “It will be remembered by many that I was not amongst those that favoured the institution of country banks; but it is apparent that the establishment of a public bank in this state has saved many of our citizens from great losses, and probably some from total ruin -– for it is obvious that but for this establishment, in lieu of our own Vermont bank bills, our citizens would on the late bankruptcies have been possessed of large sums of depreciated paper of the failing private banks …”

The private banks viciously attacked the Vermont State Bank and the community banks it supported through counterfeiting — not difficult at the time. The worthless counterfeit bills were difficult to detect. They were exchanged for the gold, depleting the gold reserves of the Vermont banks.

While the Bank of the State of South Carolina (BSSC) was not without political corruption, the bank operated successfully for 58 years, from 1812–1870. In the end, the BSSC did survive the American Civil War intact and in 1867 it still held a large amount of assets belonging to the State — some of which admittedly had questionable value.

But it was not corruption that closed the bank as implied by Calabria. Although the BSSC did have its detractors, it had many supporters. Speaking at the closing of the bank in 1870, a representative from the State Board of Agriculture remarked, “Thus passed away a powerful institution, which for more than half a century had exercised exclusive control of the financial affairs of the State. Its friends claimed that it had saved, consolidated, and made profitable the funds of the State, that it had furnished relief to many citizens and added to the general revenues of the State, improving and developing the towns of the interior. Its profits were employed in paying the interest and in reducing the principal of the public debt. It preserved its capital entire and its funds safe, maintaining the character and the credit of the State in Europe and at home without blot or suspense. Its most violent opponents admitted the ability and integrity displayed in its management, and declared that the abiding confidence of the people in it was a high but dangerous complement to the parity of the public characters of the State.”

The State Bank of Alabama was doomed to failure from its very start. The legislation that created it was ineptly crafted and this was taken advantage of by the board that ran the bank for their own profit. This is one of only two credible examples Calabria gives of how not to design state banking legislation. Clearly, we can learn from this example as well as the good example of North Dakota to understand how to design legislation that avoids excessive political influence and yet be an effective tool for the state. And a minor point: Alabama’s was neither the last state bank to be formed nor the last to fail in the first half of the 19th century.

The recent history of Fannie Mae and Freddie Mac, quasi-public banks at the federal level, illustrates that mismanagement and corruption are not exclusively a thing of the past. We can also look abroad. Germany has an extensive system of public banks, the most prominent being the Landesbanken, which like the proposal before us in Colorado, are owned by the state governments. Despite being a minority of Germany’s financial system, the bulk of losses related to the subprime crisis arose from these public banks. Years before the crisis, the IMF warned of risks hidden in Germany’s public banking system. Unfortunately those warnings were ignored.

And the operations of Fannie Mae and Freddie Mac is Calabria’s other good example of how excessive political influence can doom a public bank to failure. Although both Fannie and Freddie were privately owned, since 1968 and 1970 respectively, in the 1990s and early 2000s they were given mandates from Congress regarding what sorts of loans they should be supporting. Certainly, in part, this led to the collapse of both organizations. They were then put in government-managed conservatorship to restore transparency and accountability and many of their officials were removed from office.

However, rather than take this as an example of how all public banks are doomed to failure, it can be taken as a “lesson learned” on how not to operate a public bank. North Dakota had the foresight to a design a way of operating their bank to avoid most of the pitfalls that can cause it to fail.

In Germany, the largest set of public banks are the Sparkassen Banks, which comprise over 1,500 municipally-owned saving banks that fund a large portion of small and medium sized businesses in Germany. These banks suffered no bank closings after 2008. In fact, despite numerous attempts by the private banks to put the public banks in Germany out of business, most recently by passing legislation taking away their public insurance, like our FDIC, they continue to thrive and they help their local communities thrive as well and are an important reason why Germany has the strongest economy in the Eurozone today.

Some might point to the Bank of North Dakota, currently the only state-run and state-owned American bank. Currently the Bank of North Dakota is generally a well-run institution. It is also a massive subsidy to the fossil fuel industry. One need only look at its annual reports to see that much of its below-market lending has been to the fossil fuel industry. It’s a case in point; government-owned banks will tend to subsidize the powerful and connected. Most of its risk is ultimately shifted to the federal government via various guarantees.

If Mr. Calabria had done as he has suggested his readers do, and actually looked at the Bank of North Dakota’s annual reports, he might have noticed that loans to the oil and gas industry are not their main target. In fact, as of 31 December 2014, only $305,927,000 of the commercial loan portfolio was committed to oil country-related loans. The commercial loan portfolio as of that date was slightly more than $1.5 billion and the total loan portfolio is $3.8 billion (these numbers are from private communications with the Bank of North Dakota and will be finalized in their 2014 annual report to be released on April 2015). So let’s do the math — oil country-related loans comprise less than 8% of the Bank of North Dakota’s total loan portfolio. This is certainly dwarfed by the free market investment in North Dakota oil and gas.

Furthermore, most of the risk of these loans is absorbed by the State of North Dakota, which currently has a Double-A+ credit rating. Further, the Bank of North Dakota currently has a Double-A- Standard & Poor rating — among U.S. financial institutions, second only to the Federal Home Loan Banks, rated Double-A+.

The vast majority of funding for the Bank of North Dakota comes from deposits resulting from tax and fee collections. The bank essentially offers below market rate loans by paying lower deposit rates back to the State, ultimately costing the taxpayer. It’s not magic. It is simply a hidden subsidy. Rarely is such a lack of transparency in the interests of the general public.

It is very clear that Calabria has little understanding of fractional-reserve banking. Otherwise, he would understand that even if the Bank of North Dakota did make its loans at “below market rate”, that it can loan out up to nine times its equity. The return on equity for the Bank of North Dakota has averaged around 20% over the last decade. And rather than ‘costing the taxpayer’, it has returned over $300M back to the state of North Dakota during that time period.

Note that the Bank of North Dakota does make loans that Calabria would consider “below market rate” in certain areas that the government deems beneficial to the citizenry — like student loans, some of which are made at as low as 1% per annum.

These are not simply theoretical curiosities. Academic research actually tells us what happens when the government owns banks. The most comprehensive study1, from economists at Harvard University, finds “that higher government ownership of banks is associated with slower subsequent development of the financial system, lower economic growth, and, in particular, lower growth of productivity.” Keep in mind that productivity is ultimately what drives wage growth. This research has been extended in a recent paper2 that attributes much of the worse outcomes to political interference in bank lending decisions.

We will address, in a future post, why we believe the models in the academic research Calabria mentions are not applicable to some of the public bank structures that are clearly working. We give here several counter-examples to what he believes the papers conclude — the BRICs (Brazil, Russia, India, and China) in the following paragraph and the Bank of North Dakota and the Reconstruction Finance Corporation following the text of Calabria’s next paragraph. We include the two papers that support his position, in addition to several we quote, at the end of this post for those who would like to look in detail at these studies.

In the international scene, the BRICs, heavily into public banks, have clearly outpaced the western world, with their private banking system. The BRICs growth rate was 6.5 percent per annum in the previous decade whereas the industrial world had a growth rate of 1.5 percent during the same period. While this certainly cannot be attributed completely to the fact that they have an extensive public banking system, it would be hard to argue that the banking system has hurt their economies.3

When the government owns the banks, lending decisions become increasingly driven by politics, rather than economics. Resources flow to those with influence. Government-owned banks also tend to under-price risk in order to buy votes. If there is one lesson we should take away from the recent crisis, it is that when you intentionally under-price risk, bad things happen.

North Dakota has come up with a successful model for a state-owned bank. Only general policy and oversight is done by the legislature. A three-member State Industrial Commission oversees Bank of North Dakota, composed of the Governor, the Attorney General, and the Commissioner of Agriculture. The Bank has a seven-member Advisory Board appointed by the governor. The members must be knowledgeable in banking and finance. The Advisory Board reviews the Bank’s operations and makes recommendations to the Industrial Commission relating to the Bank’s management, services, policies and procedures. This is a system that has worked for almost a century. It is certainly a model that can be adapted to Colorado.

Another public bank that deserves attention because of its great success is the Reconstruction Finance Corporation, which operated as an agency of the U.S.government transparently and without scandal or fraud from 1933 to 1957. It was the largest bank in the world and the largest corporation in America at the time, providing financial support to state and local governments and making loans to banks, railroads, mortgage associations, and other businesses. It played a major role in pulling the U.S. out of the Great Depression, helping banks return to normal operations, and in funding World War II. It loaned $35 billion into the economy in the years 1933 to 1945. Congress having deemed it was no longer needed, reduced its size after World War II and eventually closed it in 1957. The Reconstruction Finance Corporation operated with great success and benefit to the country.

In contrast, the behavior of the big Wall Street banks has been a model of mismanagement and fraud in service of their own interest — against the interests of their own customers and the public. Their power over the political system is so great that they have become too big to regulate, too big to prosecute, and too big to fail. The American citizens have borne all their losses — through loss of wealth, jobs, income, and pensions.

Anger at Wall Street is well founded. But you have plenty of options besides Wall Street. Colorado has 96 independent community banks and 91 credit unions. That’s not to mention growing alternative sources like peer-to-peer lending and crowdfunding. Borrowers and savers have lots to choose from, with the emphasis on choice. There’s no good reason to force these institutions to compete with a state-owned “political” bank.

In Colorado, the community banks and credit unions are currently unable to meet the needs of small and medium-sized businesses. And the Wall Street banks are unwilling to do so. Further, as in the North Dakota model, a state-owned bank would not compete, but partners with, community banks and credit unions to make loans to deserving businesses. In fact, as a result of the support of the Bank of North Dakota, there are more community banks in North Dakota than in any other state in the U.S — according to the FDIC, 81% of banks in North Dakota are community banks. During the last decade, banks in North Dakota, in partnership with the Bank of North Dakota, have averaged over four times more small business lending than the national average.

Mark A. Calabria, a former senior aide to the Senate Committee on Banking, Housing and Urban Development, is the director of financial regulation studies at the Cato Institute.


1 The most comprehensive study

2 A recent paper

3 Mutually assured existence | The Economist

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