The 2008 financial crisis plunged much of the world economy into a deep recession from which many countries, including the U.S., are still recovering. The economic costs have been staggering while political systems have been severely destabilized. Unfortunately, given the unchanged nature of the financial system, it appears to be only a matter of time before the next crisis hits.
In "The Crisis Next Time," a publication of the Democracy Collaborative, Thomas Hanna writes that there is a better way. Instead of bailing out failing financial institutions and then letting them go back to the same risky behaviors that nearly brought down the economy, the U.S. government should take full ownership and turn them into public enterprises that permanently operate on an entirely different basis. But this is not just a technical solution that can be applied easily; it is a different policy direction that must be planned for and must receive substantial political support.
As Hanna stresses, the time to do this planning is now – before the next crisis.
The various elements of the 2008 disaster in the U.S. – home foreclosures, high unemployment, bankruptcy in pillars of the U.S. economy, and the stock market crash – are well known and don’t need further explanation here. But in much of the mainstream discussion about what happened, the structural factors that brought on the crisis tend not to get the attention they deserve, especially since they remain much as they were before the crisis.
Hanna provides a useful summary of these problems. Over the past couple of decades, the FIRE sector (finance, insurance, and real estate) significantly increased its share of the U.S. economy and corporate profits. This led to increasing inequality (in combination with stagnant wages), slow growth in other economic sectors, growing household debt, and general instability caused by the ups and downs of the stock market. At the same time, the FIRE sector itself became increasingly concentrated as a large number of small and medium-sized institutions went out of business and were acquired by the behemoths.
In addition to these broad structural trends, the financial sector itself turned into something of a wild west economy as increasingly risky bets were made on questionable mortgages, while complicated financial instruments made a large volume of transactions opaque to regulators and to the traders themselves. Many of these practices were illegal. Hanna lists 21 examples of fines and settlements CitiCorp alone paid in the wake of the crisis, amounting to more than $10 billion.
As became clear in 2008 and 2009, most of the major institutions that became insolvent were “too big to fail.” Had they been allowed to collapse, they would have taken down the entire economy with them, including the savings and investments of millions of Americans. This was and remains one of the key problems of the FIRE sector.
On the one hand, the “free market” reigns when it comes to government regulation, meaning minimal government oversight. On the other hand, the market cannot be allowed to discipline losers by letting them go bankrupt. While gains from speculation accrue to managers and stockholders, the risks and bailout costs are borne by the general public.
Once the big banks and insurance companies were bailed out and stabilized, the Obama administration worked to enact reforms to prevent another crisis. These reforms, mostly encapsulated by the Dodd-Frank legislation of 2010, addressed some of the structural problems that had led to the crisis (see the Wikipedia page for a full explanation of the legislation).
Among the most important provisions were restrictions on speculative investments, greater transparency surrounding derivatives, and the establishment of the Consumer Financial Protection Bureau. Closer oversight of the financial health of large financial institutions was also part of the legislation. Although many of the law’s provisions were positive in the sense that they partially restricted banks’ ability to speculate and protected consumers, almost one-third of the regulatory rules were never finalized. Among those rules that were finalized, many were weakened by FIRE lobbyists in Congress. With the advent of the Trump administration, Dodd-Frank has been further undermined, both in terms of regulatory oversight and recent legislation.
Hanna observes that the difficulty in regulating the financial sector is ultimately political. Compared with reformers and other organized interests in society, the financial sector has substantial power to shape and then bend rules to its advantage. Hanna mentions five key factors.
First, Wall Street engages in an immense amount of lobbying, spending over a billion dollars in 2016 and 2017 according to the Center for Responsive Politics (cited by Hanna). Second, to supplement that pressure, the FIRE sector makes substantial contributions to political campaigns. Third, there is a revolving door between government and Wall Street, seen most obviously with Goldman-Sachs. Despite Trump's anti-Goldman Sachs rhetoric during the campaign, he brought several former Goldman-Sachs executives into his administration. Obama also staffed his administration with Goldman-Sachs alums.
Fourth, there is a cozy relationship between government officials (especially from the Treasury Department), bankers, and lobbyists. There is no need for these people to actually conspire with each other, although that no doubt happens on occasion. Rather, they simply see the world in the same way and therefore push in the same policy directions.
Finally, there is the problem of "regulatory capture," an evocative term that refers to the association of regulatory institutions with those they are supposed to regulate. Again, this is mostly a matter of common worldviews. Hanna quotes former FDIC chair Sheila Bair who said:
"[W]hen I say capture, I'm talking about cognitive capture. It's not so much about corruption. It's just listening too much to large financial institutions and the people who represent them and not enough to the people out on Main Street who want this fixed."
In sum, the FIRE sector is able to use its lobbying and its closeness to power in the executive branch to maintain a position of influence in policy-making and policy-implementing circles in government. This position of strength is not new. It helped bankers and their allies overturn the Glass-Steagall legislation during the Clinton administration. But, it is at the height of its power now as seen in its ability to minimize the effects of Dodd-Frank and then undermine much of it in short order with the arrival of the new Republican administration.
What then is the solution? We must fully come to grips with the likelihood that there will be another major crisis and that we must plan for it. That plan, in Hanna’s words, should be to “cleanly and transparently” take “failing financial corporations into genuine public ownership”...permanently. No bailouts using public funds belonging to taxpayers with minimal regulatory oversight and then giving the corporations – newly made whole – back to their private owners in order to accumulate more private wealth until the next big crisis. That cycle must be broken if we are to have an economy that actually works for the majority of citizens.
The idea of publicly-owned banks and other financial institutions is largely foreign to Americans, at least in the narrow public discourse of the Wall Street Journal, network financial experts, members of Congress, and other business-friendly outlets, which still default to the “market is best” doctrine. But there are many examples of public banking in advanced industrial economies that are successful and, in fact, have a much better record of financial solvency, while directing capital to productive enterprises instead of speculation.
Scandinavian countries nationalized large banks during a crisis in the 1990s and in the wake of the 2008 crisis, nationalizations occured in Belgium, Ireland, Iceland, Mexico, and other places. Germany has numerous local and regional banks – Sparkassen and Landesbanken – that are owned by cities or groups of cities and generally are not profit-oriented.
An example of a public bank can also be found here in the U.S.: the Bank of North Dakota. This state-owned bank helped local banks and the state as a whole get through the Great Recession in better shape than much of the country. North Dakota had the lowest foreclosure and credit card default rates in the U.S.
In addition, there are dozens of public banking initiatives under consideration across the U.S. and the creation of a public bank is on the ballot in Los Angeles in November. The idea of public banking in the U.S. is already gaining momentum.
The arguments against public banking come very much out of the “market is best” worldview, namely that market incentives ensure the greatest efficiency and avoid corruption associated with government. There are multiple problems with such assumptions, however. When it comes to the FIRE sector (not to mention many others), there is no “free market” in the sense that businesses compete to sell the best services at the lowest prices to consumers. Instead, the reality is that the FIRE sector is heavily concentrated, which limits competition. All have large revenue streams based on rent-seeking and speculative practices. There is nothing like a “free market” to promote competition in corporate finance, insurance, and real estate.
The overriding point, as Hanna notes, is the sobering fact that the FIRE sector caused an immense crisis that bankrupted millions of families, caused millions of mortgage foreclosures, and caused the biggest economic crisis since the Great Depression. A large economic sector that causes such economic devastation is the antithesis of “efficient.”
Another common argument against public banking is the potential for corruption and cronyism that would be the result of government management of such enterprises. Again, existing banking, insurance, and real estate institutions already display significant corruption in terms of regulatory capture, lack of transparency, relatively modest and compromised government oversight, dishonesty in the valuations of various financial instruments, and bogus account manipulations such as those of Wells Fargo that have emerged in the past year or so. These institutions put at risk the health of the entire economy and the livelihoods of nearly all Americans. Simply stated, the key arguments against public control of the banking sector only point back to the large problems that currently plague the privately-owned banking sector.
What would be involved in taking private banks and other financial institutions into the public sector? How would they be operated? In terms of the act of taking over the banks, Hanna observes that the most plausible route would be through government bailouts during the next crisis. But this time the government would maintain ownership and continue to operate the banks as public utilities that could channel resources into underserved areas. Some could be broken up into regional or state banks as the Labour Party in the U.K. has proposed. Others could be devoted to providing capital investment in infrastructure, renewable energy, higher education, or research and development, to name a few options.
As for the operation of such public institutions, the examples mentioned above provide a range of ideas for governance that would combine public input, expert advice, and autonomy of the banks along with clear guidelines that limit executive compensation, ensure a healthy amount of executive turnover, and establish metrics of success. But these are just some basic principles. There would be many more worked out in the process of writing and passing legislation when the time comes. Governance is a major focus of public banking advocates, who are all about democratizing the economy, as discussed in this segment of a recent episode of the Laura Flanders show.
The drafting of such legislation would be a complex and possibly extended process. But putting together clear objectives and filling in the details about implementation can and should be done ahead of time to expedite the process once the crisis hits. This is the point of the entire paper. Progressives must be ready with detailed plans, even actual legislation if possible, in order to respond quickly during the next crisis.
There must also be a political push – now – to normalize the idea of public sector banking. Hanna quotes a Newsweek poll taken during the 2008 crisis in which 56 percent favored nationalization of the banks, while only 29 percent favored government financial assistance without government control. That polling, as positive as it was, took place without public discussion. Hanna argues that “[s]uch sentiments can naturally be deepened into widespread support for longer-term public ownership in the sector if a coherent vision is available to pull ‘off the shelf’.” As with most progressive ideas, the potential exists for broad public support if liberals and progressives will only make a forthright case for them.
Such political work is already being done in the many local and state initiatives promoting public banks. The deepening support Hanna refers to appears to be building already, even if a “coherent vision” has not yet come into view. Such efforts should be combined with initiatives to educate the public more broadly about how banks and monetary policy function.
In addition, progressives must build a cadre of technical and policy experts to staff regulatory agencies, government departments such as Treasury, and Congressional committees. Any successful effort to nationalize banks will be met by concerted opposition in government and in the political realm. Advocates of public banking will need all the political power they can accumulate in government institutions, civil society organizations, and public opinion to create and maintain a public banking sector.
