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The Public Option in Banking

posted by Adam Levitin

The postal banking idea has been getting a lot of attention.  See, e.g., here (David Dayen) and here (Elizabeth Warren). Yet, the more I think about it, the more I wonder if the postal part of the idea is actually convoluting things. The point of postal banking proposals is not any particular connection with the post office. Instead, these are proposals for a public option in banking.  I think it would be helpful to reframe the discussion in these terms, and not have it tie up with post office issues.  What follows is a sort of tenative case for a public option in banking plus some thoughts of what it might look like, including a right of first refusal for public capital (a put up or shut up provision). 

(1) Separate the Public Option Discussion from the Postal Office

The post office does have a history of having provided banking services, and it does have an excellent physical branch network (although perhaps not optimized for banking) and existing cash handling capacity.  The USPS is also looking for new revenue sources. 

Yet, the quest for revenue potentially complicates any attempt to use postal banking for financial inclusion, and any proposal for postal banking is immediately tarred with all of the perceived flaws in postal operations.  So perhaps, the point here is not postal banking, but that we need a public option in banking.

(2) Public Options in Banking, and the Tenuous Public-Private Divide

The idea of a public option in banking is not exactly new.  We already have a state government bank, the Bank of North Dakota, and a government bank can be thought of as a mutual for the entire country.  There are plenty of problems lurking with government banking, particularly the risk of politicized allocation of capital, rather than lending decisions made purely on a risk-reward basis. Conservative critics of the current banking regulatory system would argue that we're already heading dangerously in this direction with things like the Community Reinvestment Act and the GSE Affordable Housing Goals.  (See here for my thoughts on this issue regarding housing.)

And yet the truth is that the public-private distinction just isn't that sharp in banking. Instead, one of the major regulatory problems in banking is the privatization of gains coupled with the socialization of losses.  (Admati & Hellwig explain this in exemplary fashion.) The effect of such a system is to artificially subsidize the financial services industry. What's more, the government already formally bears the direct risk of loss in significant parts of the consumer and business lending markets:  student loans, FHA/VA/RHS mortgages, SBA loans.  The government also implicitly bears the risk for much of the rest of the housing market (Fannie/Freddie), and for the banking system as a whole (FDIC insurance). In other words, the taxpayer is already neck deep in exposure to financial services. 

(3) Why Should the Government Be Doing This?

Still, even the Slips' Very Own Bob Lawless, hardly a card-carrying Randian, pushed back when I bruited the argument for a public option in banking with him, "Why not have the government run grocery stores where people need them (i.e., fix the proverbial food desert)?"  Fair point, but...  We do that already, sort of.  We subsidize food via food stamps. But for food stamps, there would be even less consumption ability in poor neighborhoods, which would mean that grocery options would be even more limited. We also affect what kind of business is operated where, via zoning laws.  And the government operates PXs for military and certain civilians (100% disabled veterans, e.g.).  

It's fairly well accepted that government intervention is appropriate when a market failure occurs. (I'm not going to bother arguing with those types who pretend that markets never fail.) The question is how should the government respond. Surprisingly, the literature on which regulatory tool to use is quite underdeveloped (see here and here for some thoughts).  There are a range of regulatory responses available to market failures, such as banking services or grocery stores for the poor.  One response is a public option.  Another would be Pigouvian taxation or subsidization. Another would be conditional licensing (e.g., to operate a store in location X, you must also operate a store in location Y).  Another would be non-mandatory conditional licensing like we do with the Community Reinvestment Act (if you want to get regulatory approval for certain things, you must show that you are reinvesting in the communities you serve). There might be other routes that I'm not thinking of right now.

Historically, when the United States has wanted to ensure service to underserved markets, it has utilized a public option. The prime examples of this are the Post Office, public roads, public schools, and public utilities like the Tennessee Valley Authority.  But for government regulation, we would not have free rural delivery of mail. We subsidize free rural delivery both because of the political economy of the post and because we think it is important to maintain informational ties to all parts of the country. The same issue arises now with rural broadband. The use of Pigouvian taxation to mandate universal health insurance, rather than provision of a public option is actually the exception, not the rule in US history. That isn't to say that a public option is the right response here, but I don't think it can be dismissed out of hand. I also suspect it might be politically more feasible than the other solutions--can you imagine the hue and cry if we required privately-owned banks to offer certain services in certain locations? Recall how well plain vanilla went down in the legislative debates over creating the CFPB, and then combine that with a welfare angle. 

(4) What a Public Option in Banking Might Look Like

There's something to the idea of a public option in banking, but it might do better being separate from the USPS.  What would this look like?  

How's this for a starter:  offer to qualified private capital a new type of limited federal charter for providing very simple transaction accounts primarily to low-income consumers.  Have the charter be restricted to transaction accounts--taking deposits and offering of payment services (ACH, debit cards)--no credit services, including overdraft. Let the deposits bear the rate of interest on Treasury bonds (with all deposits invested in Treasuries, other than what is needed for liquidity). Regulate profit margins, like a public utility. Such an entity could then rent space from the post office or other government entities, if the locations made sense.  (There's probably no need for a 90210 postal bank o that can serve low-income Americans and would rent space from the post office (or other government buildings) if the locations made sense:  there's probably no need for a 90210 or 06830 postal bank.

It might make sense to build in a sort of first right of refusal for private capital.  Make such a charter available to all qualified takers for a few years.  If private capital is unwilling to step forward to apply for such a charter after a few years, then create a government corporation under such a charter. We'll have given private capital a fair chance to show if it will serve the market. This is exactly what we did with Fannie Mae:  charter made available to the public in 1934, but no takers, so a new government entity was created in 1938. 

There is room--and perhaps a need--for a public option in banking.  Not one that compete with private banks, but one that serves a market segment that banks do not serve and that hopefully graduates consumers into the mainstream banking system and helps ensure that all Americans can participate in the modern economy.  



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