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Occupy Wall Street, "Fringe Banking" and Public Options

posted by Adam Levitin

I happened to walk by Zuccoti Park in Manhattan yesterday, where the Occupy Wall Street protest is centered. I picked up a few pieces of protester literature. I can't say that I was in any way comprehensive in my collection. Some of the literature was just nuts, e.g., a flier blathering about admiralty law usurping the common law and the Trading with the Enemies Act. This flier could just as easily have been found at a Tea Party gathering. It gave new meaning to the term "fringe banking." 

But I also picked up a thoughtful and intelligent, for example a flier about public banking and the Bank of North Dakota (the only state-owned bank in the United States).  Hmmm.  That sounds like a public option for banking. If the financial system is broken, maybe it needs some better competition. It's not such a crazy idea. We actually already do that quite a bit in the mortgage market-FHA, VA, RHS, Ginnie Mae, and historically the FHLBs, HOLC and Fannie Mae (Susan Wachter and I have a forthcoming book chapter on this, to be posted to SSRN soon). We've even done it in straight banking--most people forget that we used to have a U.S. Post Office Bank. We have an FDIC that used to compete with private bank insurance funds (see the opening chapters of Kathleen Day's S&L Hell for a description of the private Maryland S&L insurance fund that failed). And we have federal (public) currency that used to compete with and has now supplanted private bank notes.  My point here is not to endorse public options or not, but merely to note that historically they were a response to failed private markets and should be part of the policy discussion. 


There is a huge amount of competition in retail banking (7,447 FDIC insured institutions), there's a reason that the entire industry has been moving towards consolidation for the last two decades. The problem is that deposits are concentrated at the top. BAC, JPM, WFC, C have 37% of the nation's total deposits which makes them systemically important.

I can't think of an example where the entry of a government competitor has made an industry more competitive. I find it hard that someone can suggest Fannie Mae and Freddie Mac as paradigms of success (and more recently Sallie Mae regarding for profit colleges). The reason these GSEs exist is to subsidize an industry but the government can't and shouldn't subsidize all real estate and commercial loans.

I fail to see any benefit that is tremendously outweighed from public banking.

BZhou--you're mistaking the number of banks for competition. First, most of those banks operate only in very limited geographic areas. Therefore in any living triangle between home, work, and shopping there are many, many fewer banks. I'd be shocked if there were more than 100 options in that triangle for almost anyone, and probably far fewer.

The problem, though, isn't the number of banks, but the fact that there isn't price competition between banks for deposit accounts because there's no price transparency. Put differently, the price theory of demand can't work unless consumers can tell what the price of a banking service is. I just blogged on this: http://www.creditslips.org/creditslips/2011/09/bully-for-bofa.html

As for the GSEs, they certainly made the industry more competitive in the sense that there was virtually no secondary mortgage market before they were created. Same thing with FHA--the private mortgage insurance industry had collapsed. The typical point of public options isn't to make markets more competitive, though--it's to supply socially desirable products and services when the private market fails to do so. For example, we would not have 30y fixed-rate mortgages but for Fannie.


Look at the number of institutions in some major MSA's.

Atlanta-Sandy Springs-Marietta, GA: 106
Baltimore-Towson, MD: 72
Boston-Cambridge-Quincy, MA-NH: 131
Chicago-Joliet-Naperville, IL-IN-WI: 229
Dallas-Fort Worth-Arlington, TX: 166
Houston-Sugar Land-Baytown, TX: 103

Number of competitors in a market is determined based on its size but only the most rural areas have less than 10 banks to choose from. Secondly, you completely discount on-line banking. ING Direct has 0 physical retail branches but $82 billion in deposits. It is an INTENSELY competitive industry.

I don't know what you mean by "lack of price transparency," to me, it's always been pretty clear what yield I get from my deposits and what the overdraft fees are. Secondly, I think the reason BofA chose to implement the debit card fee has as much to do with current interest rate conditions. The counterexample is BNY Mellon having to charge a fee on deposits to a large institutional clients. Surely there's informed customers there willing to look for competition, yet BNY still decided to charge negative interest rates.

You wrote "The typical point of public options isn't to make markets more competitive, though--it's to supply socially desirable products and services when the private market fails to do so." I think that gets to the point of the issue, it's not so much more competition you care about, it's lower prices. Subsidizing all loans means that you are underpricing the perceived risk. This is the problem that China's shadow banking system is currently facing in that you have investment capital being misallocated which creates the potential for huge value destruction. That's something I would like to have my government stay out of.

Hmm... is the 30-year mtg "socially desirable"? It's not the global standard. How about 30-year student loans? Long-term loans are certainly desirable for securitization.

I thing BZhou's challenge is worth considering. Can anyone name an industry in which the entry of a public provider (not a heavily subsidized private start-up) has made the industry more competitive? Often, gov't entry results in a public monopoly or is done to provide a service that is unprofitable for the private sector.

I'm all for a "public option" in healthcare and regulating banks like utilities, but I'm not seeing this one.


The number of banks in an MSA is kind of irrelevant to a consumer. If I live on the North Side of Chicago, a bank that only has a presence in Naperville or Joliet or even on the South Side of the city is as useless to me as one in Las Vegas. So we're talking about a much smaller number of institutions that have a relevant physical presence.

Now yes, there's on-line banking, like ING Direct or USAA. But lots of consumers still want a brick and mortar presence for various reasons. That may change over time, but on-line only is still a small part of the industry.

The reason you're not following the lack of price transparency point is that you're understanding price to be yield and overdraft fees and nothing more. Those are important parts of the total pricing bundle, but not the whole thing. If you really wanted to compare pricing, you'd need to include all of the contractual terms, ranging from arbitration clauses to availability schedules (yes there are federal requirements, but competition can and does go above that) to on-line services offered to monthly fees and other features. There's no way to easily compare this. By contrast, if you were just looking for a place to get a CD, it'd be pretty easy, and that's why there's such a big brokered deposit business. But for the full retail suite, it's comparing apples and oranges.

On some level, yes, there's likely a subsidy via a public option, but subsidies make sense when they are promoting a product with positive social externalities, like long-term fixed-rate mortgages. Putting interest rate risk on consumers with short-term adjustable rate mortgages is a recipe for disaster, but that's what the market does everywhere except where the government intervenes.

I'm not following the China comparison--are you referring to the Chinese state banking system allocating capital based on political considerations?

The 30 years isn't the point. It's that it's long-term. 15 or 20 years would probably be better than 30 (30 was an affordability nod to GIs post WWII).

Long term loans are necessary if consumers are to be making major purchases on credit. Now we could get rid of that and have much lower homeownership rates, etc. but that'd be a negative trade-off in my book.

As for government entry making an industry more competitive, how about this: the Federal Reserve's entry into the check clearing business. The Fed mandated par clearing for its members. Par clearing avoids the deadweight loss of discounting (as risk averse or informationally limited parties will not discount properly). The Fed's par clearing standard then spread and became industry practice.

Adam, as you know, not everyone shares that view about nonpar check clearing pre-Fed. I think there's a pretty decent argument to be made that pre-Fed nonpar clearing was due to network costs, not per-check transaction fees.

WRT the 30-year thing, Danish RE has done alright and they don't have much in the way of 30-year or the same level of homeownership. Pretty much kick the U.S.A.'s butt in many metrics. What up with that, yo?


You're assuming that all the banks only have branches on one side of town? I don't think this is going to be a fruitful argument because nobody can explicate a brightline for what "enough" competition is adjusted for the size of a region and its population density and then meet the burden of proof for enough geographic areas. I think a better way of telling whether an industry is competitive or not is to look at the number of companies over time. If capitalism works, the number of companies in competitive industries should go down over time (assuming that the demand is still robust). That is exactly what has happened in the banking industry.

I think it's important to make a distinction between transaction accounts and time deposits, to my understanding, your add on considerations mostly apply to the latter. To that extent, I don't think it's a lack of information, it's more that the consumers don't care all that much. It's my belief that people shop for CDs more like they shop for groceries, some will just buy the brand name, others will look at the price and the calories and maybe the sodium, in the end, very few people take the time and consideration to compare every nutritional aspect against every substitute. Furthermore, if there was a demand for such detailed information, there would be a vendor to supply it. Indeed a number of websites have proliferated to help consumers screen for the most attractive CDs. I don't understand why a national bank would change this situation, if you just want more disclosure then all you need to do is put a standardized nutrition label on CDs.

I was referring to the Chinese banking system. They repress rates for depositors to make cheap credit available to SOEs which are involved in a number of "high tech" and real estate development businesses. If you're trying to adjust for externalities, I don't understand why that can't just be done through taxes and tax breaks. The amount of taxpayer capital you put at risk is much less, and you preserve a free market to determine prices.

The flip side of the long-term fixed rate mortgage is that it killed the Savings and Loans industry when Volcker let interest rates float, which capped off the birth of securitization as a way for banks to control their asset and liability duration. In that way credit risk was transferred from the borrower to the bank to the investor (and sometimes back to the taxpayer), under a national bank it would just be from the borrower to the taxpayer.

There is the argument that retail banking is a utility like electricity or water and should be regulated as such, and strongly fenced off from any investment banking activities.

Such an arrangement is being strongly pushed through in the UK - 'ring fencing' they call it. I guess we had such an arrangement with Glass–Steagall before it was short sightedly repealed.

A government-owned bank might arguably help with business lending, but I don't see it making any difference with consumer banking.

The tragedy of consumer banking is that an honest banker will lose its shirt to a banker who does a good job of obscuring costs. The honest bank will not even gain smart customers--the smart customers will game the system, and benefit at the expense of the unsophisticated. (E.g., a credit card convenience user.)

There is no substitute for good regulation.

Of course, you could also argue for publicly-held lenders for lots of reasons in addition to your competition point. We have federally-subsidized loans because we think that there is a failure in the market for educational debt: income smoothing increases lifetime welfare, but because of asymmetric information it's a market for lemons.

Once you make a case for market intervention, economic theory then doesn't cleanly explain why we should pick subsidies over public ownership. Subsidies allow some of the surplus to be captured by private lenders. But then government ownership, as other commenters point out, can have its own pathologies (although not all government entities have to be designed as badly as Fannie & Freddie).

What about allowing industrial companies to own banks like in Canada ala Canadian Tire Bank and Walmart Canada Bank. I also note in Canada they have a single debit cards network with no interchange fees in Interac and in many ways there is more competition among the Big Six than among the US Big Three(JPM, BAC, and WF). Plus if you live in a major city in Canada such as Vancouver or Montreal you probably have a branch of HSBC or another Asian bank nearby along some big regional institution in parts of the country such as Desjardins, Laurentian, ATB(publically owned by Alberta), and Canada Western.

How's that whole Fannie Mae thing working out? Are we seriously citing that as a model for ANYTHING?

I'd have hoped one thing we could all agree on from this mess is that if the private sector doesn't want to provide a service doesn't mean the public sector should step in automatically. State run companies can distort and discourage competition from the public sector. It's really no surprise (in hindsight) that the financial crisis began in the sector of finance most publicly directed (housing).

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