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Don’t bank on this financially illiterate idea going away - Pacific Research Institute

Don’t bank on this
financially illiterate idea
going away

By Sal Rodriguez | August 3, 2023

Over the last few years, city officials in Los Angeles and San Francisco have flirted with the idea of establishing public banks to ostensibly support or facilitate the cause of the day.

San Francisco is much further along in the process. A working group established to help outline a business and governance plan for a public bank has already submitted its findings to the San Francisco Board of Supervisors for consideration.

In Los Angeles, just a few years after voters rejected a proposed public bank, the City Council voted in late June to commission its own feasibility study on how public banking could work. 

City leaders in both jurisdictions have high hopes for what city-owned banks could accomplish – from better serving low-income and minority communities to facilitating affordable housing and green energy investments.

But in a world where plenty of privately run banks and other financial service providers with long track records exist, the concept of public banking makes little sense on its face and even less when considering the actual history of public banks.

This is a gamble neither jurisdiction should take.

Public banks have a history of failure 

The idea of publicly-owned banks is nothing new, nor are the fundamental problems. Indeed, the early history of public banks paints a picture policy makers of today should heed.

The first known public bank in history traces to the Banco di San Giorgio in Genoa, Italy. Established in 1408, the bank later failed, “in part because of losses on loans to its sponsoring government,” as noted by the Cato Institute’s Mark Calabria in 2015. 

The first public bank in the United States – established in Vermont in 1806 – didn’t fare much better. It failed within six years, as Calabria wrote, “costing the citizens of Vermont the equivalent of almost $3 billion in today’s dollars.” 

A string of bank failures in the American South prompted South Carolina lawmaker James Felder in 1846 to observe, “One of the great curses in our state is the vile concubinage of bank and state. Whenever such cohabitation exists, the bank runs into politics and politicians run into the bank and foul disease and corruption ensue… .”

Read Sal Rodriguez’s
Pacific Research Institute
book, “Dynamism or Decay?”

Felder’s remarks point to the fundamental problem of public banks – they enmesh distinct systems in ways that aren’t often sustainable. This has been validated not just by a cursory review of the history of public banks, but also empirically.

 

Academic research of government-run banks around the world published in the Journal of Finance in 2002 concluded that, “government ownership of banks is associated with slower financial and economic development.” 


Their empirical findings, the authors note, are consistent with the view that “such ownership politicizes the resource allocation process and reduces efficiency” of how banks are supposed to function. 


And yet, the idea persists. 


Los Angeles should have learned its lesson by now

The city of Los Angeles has direct experience with a public bank and public bank failure. 

The Los Angeles Community Development Bank (LACDB) was created in the 1990s as a response to the 1992 Los Angeles riots. It was part of an effort by the federal government to help make loans to small- and medium-businesses in so-called “empowerment zones.”

It was a “noble idea,” as described by economists Robert Krol and Shirley Svorny in a 2005 study of the bank, but one that was doomed to fail. The bank was jump-started with $435 million in grants and loan guarantees from the federal government to the county and city of Los Angeles, which then sent the money to the LACDB.

Fully operational by 1996, the bank was tasked with providing loans “exclusively toward businesses whose applications for credit had been rejected by private lenders.” 

You can see where this is going. “Little thought was given to the perverse incentive effects associated with creating a publicly funded, nonprofit lending institution that would be inclined to issue risky loans that could lead to its insolvency,” noted Krol and Svorny. 

Over time, the bank consistently missed job-creation and retention targets, failed to recruit substantial private-sector assistance and by 2004 was shuttered. And yet, Los Angeles city officials have made repeated attempts to resurrect a public bank. 

In 2017, then-Los Angeles Council President Herb Wesson became particularly interested in establishing a city-run bank which could help finance affordable-housing development as well as handle transactions for the nascent cannabis industry. 

The latter part of that was ultimately dropped, but the city went ahead with putting a ballot measure before voters to amend the Los Angeles city charter to permit the establishment of a “purely commercial” public bank. In 2018, the measure was soundly rejected, with 58 percent of Angelenos opposing the proposal.

City officials weren’t ready to take “no” for an answer, however. In 2021, the Los Angeles City Council’s Economic Development and Jobs Committee advanced the creation of a Municipal Bank of Los Angeles. This prompted economist Shirley Svorny, 16 years after writing about the failure of the LACDB, to blast the proposal as having many of the same fundamental problems as the last failed public bank.

“The Public Bank LA plan is incredibly naïve,” she wrote in a commentary for the Los Angeles Daily News. “The bank would lack geographic diversification in lending, the oversight plan would put individuals in charge who have no banking experience, and special interest influence would lead to bad loans and bank failure, taking the city’s deposits with it.”

The plan was shelved for a couple of years, but has since been revived. In June of this year, Los Angeles’ self-described democratic socialist Councilmember Nithya Raman spearheaded a proposal to study the idea once more, because the last 600 years of public bank failures haven’t been enough.

“I think what’s really exciting is that we have a potential to fill the gaps that our reliance on commercial banking has left us with,” Raman said in support of the idea. “I think those gaps are really felt most keenly for communities of color, and for working class people.” The council unanimously approved conducting the study.

San Francisco takes up the unworkable idea

In 2019, the California Legislature approved Assembly Bill 857, introduced by then-San Francisco Assemblyman David Chiu, which made it easier for local governments to charter their own public banks. 

“Our public money should serve a public purpose and our local communities – not lining the pockets of Wall Street investors,” Chiu said in advocating the bill. San Francisco was the first to pounce on the expanded powers under A.B. 857.  

In 2021, San Francisco supervisors took the coronavirus pandemic as a sign that what their city really needed was a public bank.   

“During a global pandemic when San Franciscans are facing massive unemployment, rent debt, and financial insecurity, billionaire wealth has surged,” Supervisor Dean Preston told San Francisco Weekly in a statement. “As we chart a path to economic recovery, we must ensure that our city dollars are used to correct the inequities in our city. I am excited to take this next major step alongside the San Francisco Public Bank Coalition to establish the nation’s first municipal public bank.”

Preston and his fellow supervisors signed off on the plan, which tasked the San Francisco Reinvestment Working Group to study the idea. 

According to the resulting document, the proposed bank would serve as the city’s “green bank” to help the city “address environmental injustices” and “provide low-cost loans for projects that reduce emissions.” The bank would also focus lending activities on supporting affordable housing, small businesses and “green investments supporting environmental justice.”

The feasibility study acknowledges that, while feasible, “over the past year several events have occurred within the financial industry and the overall economy that have an impact on the creation of a public bank and the ability to secure, within a reasonable period, the required regulatory approvals.” This includes recent bank failures close to home (like the Silicon Valley Bank) and increased fiscal pressures on local governments amid inflation and an uncertain economy. 

Alas, the proposal is now off to the board to review.

Conclusion: Cities should dump this terrible idea

If public bank proponents should learn anything from the history of public banks, it’s that public banks are a really terrible idea. The mixing of politics with banking is a recipe for disaster. 


City governments should focus on the basics and master their core competencies, not venture out into risky new ventures which could come at great expense to taxpayers and the credibility of government officials.

Sal Rodriguez is opinion editor for the Southern California News Group and a senior fellow with the Pacific Research Institute. He is the author of “Dynamism or Decay? Getting City Hall Out of the Way,” published by the Pacific Research Institute.

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