#2 Public Banking

“…banks make their profits by taking in deposits and lending the funds out at a higher rate of interest” said Paul Krugman in 2015, demonstrating that a Nobel prize-winning economist, doesn’t know what banks do.
So far, it’s clear that currency creators are fiscally unconstrained, despite the existence or entirely optional, self-inflicted limitations like the “debt” ceiling. It’s even reassuring to know currency creators can never be involuntarily insolvent, so worry about “going bankrupt” like Greece (which cannot make its own euros) is not an issue, ever for the U.S. But, like households (and Greece), local and state governments are currency users, not currency creators.

Fortunately, public banking provides solutions that can ease state and local governments’ fiscal constraints.

In general, banks create money too. Banks do this by extending credit with fractional reserve lending. One commonly cited estimate of the amount of bank-created money in the economy: 97% of the money in circulation.

Fractional reserve lending originated with medieval goldsmiths, who stored people’s gold and issued receipts. People storing gold discovered the receipts were more convenient to use as money, and began doing so. Goldsmiths also discovered people seldom retrieved their gold, so they could issue more receipts than they had gold--and in doing so invented “fractional reserve lending.” The downside of this practice: When everyone wants their gold at once, that’s called a “run on the bank.”

Note: Even private, commodity-backed currency like the goldsmiths’ receipts are IOUs. In this case it’s “IOU a lump of gold.”

Modern bankers create money by lending more than they have on deposit--in this case dollars, not gold, is what’s on deposit--but the principle is the same. Banks do not lend their dollar reserves.

By issuing a loan, banks create money, typically by opening a checking account for the borrower. From the bank’s point of view, the IOU (note) from the borrower describing what’s owed and how it will be repaid is the bank’s asset, while that checking account is the bank’s liability. Notice: no reserves appear in this bookkeeping.

So if buyers borrow to buy a house, they write the sellers a check on that new checking account created for the mortgage. If the seller banked at the same location as the borrower, the bank would simply shift numbers between the buyer’s account and the seller’s account. No deposited dollars would change hands. If the buyer and seller bank at different locations, then the Fed settles any imbalance, and makes sure all banks have the required amount of reserves. Banks can borrow reserves without limit from the Fed too, at less than one percent interest a year!

Banks are, and must be, heavily regulated. They must have a minimum amount of reserves and adhere to several other restrictions to have the license to make money this way, and to get Federal Deposit Insurance that prevents runs on the bank.

In any case, the saying is “Loans create deposits.” Notice also that the borrower’s asset (checking account) and liability (mortgage note) are equal, as are those things on the bank’s books--the borrower’s checking account is a bank liability while the mortgage note is a bank asset.

The difference made by a public bank is that public benefit, rather than profit, would determine the kinds of loans available. One local example occurred with the Transit-Oriented Development (TOD) Phil Angiledes attempted in Laguna West. To be successful in lowering environmental impacts, TODs require higher-density housing so enough patrons can walk to the transit stops or local commerce to make them viable. Working TODs can cut vehicle miles traveled roughly in half, compared to sprawl.

Oddly enough, no apartment or condo construction financing was available from private lenders when Laguna West builders tried to build high density housing. Could banks avoid loans that would impair their profitable auto loan (and auto inventory loan) business? Could private profit trump public benefit? And is the pope still Catholic?

...OK, in fairness, I’ve been told by a knowledgeable banker (Modern Money Theory founder Warren Mosler) that bankers generally are just not that sophisticated in their thinking. Some other cause probably made them hesitant to lend apartment money--perhaps the proximity of the many foreclosures on apartments in the Savings & Loan scandal.

Still, notice that the public process (Sacramento County’s planning), and even a politically-connected developer (Angiledes) didn’t determine what was built. Banks did. The iron law of architecture is no longer “Form follows function,” it’s “Form follows finance.”

Public opportunities with large up-front investments that ultimately save money include “Housing First” programs for the homeless, energy-saving retrofits and solar installations for public institutions, and suburban retrofits (housing in shopping centers to make them mixed use). Private banks do not currently make such loans.

California actually has a (public) Infrastructure Bank now, but as valuable as it is, its underwriting is so restrictive that it cannot make a loan to install solar panels based on the savings a public entity might enjoy (that might have changed, but in my conversation with the bank’s chief he voiced his frustration at his inability to fund such investments in energy saving projects, never mind Housing First for the homeless, which he said he certainly could not fund).

Restrictions to its underwriting also meant California’s Infrastructure bank could not finance either the Bay Bridge seismic rebuild or the Kings’ Stadium; (private) Goldman Sachs did that. The California Infrastructure Bank’s restrictive underwriting practice really has no other reason than “That’s how it is,” too. Well, that and the standard difficulties in making good loans.

So...public banking could actually make a difference and remove the “we’re out of money” excuse for (good) projects that could save public money. It could be an essential element in a more robust, sustainable public realm, serving the public, not just private profit.

One specific proposal ECOS might back: emulate the East Bay communities’ study of public banking. It’s proposed such a public bank could fund clean energy, too. Here’s a direct link to one organization promoting the East Bay idea. I’ll post more specifics about their process as I get information from them. So far, they’ve said they want to confine their study area to Alameda County.

Should SMUD create a public bank dedicated to financing renewables installations? After all, Ford and GM made most of their profit in many recent years from financing auto purchases, not from making the cars themselves. This way, SMUD could remain a guiding force in the community even if its power supplying days ended provided it financed the technology replacing its generating power.