A candidate for New Jersey governor has proposed the creation of a state-owned public bank modeled on the nearly century-old Bank of North Dakota (BND). Declaring that “New Jersey currently deposits billions of dollars in state revenues in Wall Street and foreign banks — which overwhelmingly do not invest in New Jersey’s communities” the former Goldman Sachs partner vowed to “take that money out of Wall Street and put it to work for New Jersey — creating jobs and growing the economy [by] using state deposits to finance local investments … and … support billions of dollars of critical investments in infrastructure, small businesses, and student loans — saving our residents money and returning all profits to the taxpayers.”
Credit Phil Murphy with offering a bold idea. Before we get too excited, however, a few questions: What, exactly, is a public bank? Could a public bank really deliver all those benefits? Are there risks? What are the potential negative impacts on the private sector? Is the BND model pertinent to New Jersey? Are there better alternatives?
Let’s take a closer look.
What is a public bank? Public banks are simply banks owned by the public (i.e., the government), with a mission to serve “the public interest” rather than earn profits for private shareholders. Although there are numerous examples of public banks around the world, the BND, formed in 1919 as part of a populist-agrarian backlash against tight credit policies imposed by Minneapolis, Chicago, and New York banking elites (sound familiar, anyone?) remains the only U.S. state-owned public bank.
From the few details available, we can fairly assume that a New Jersey public bank modeled on the BND would be a state-chartered and state-owned nonprofit financial institution; that a board of state officials would oversee the bank’s professional management; that, by law, all state tax and fee revenues would be deposited in the bank instead of private depository institutions; that the bank would “invest” those monies in New Jersey infrastructure, small businesses, and federally backed student loans; that deposits in the bank would be insured by the state of New Jersey instead of the federal government’s FDIC; and that the bank would return a portion of its “profits” to the state for budget relief.
Could a public bank really deliver the promised benefits? If the BND is a valid example — a big if — the best answer is that a New Jersey public bank might be able to deliver some benefits some of the time, but on a very modest scale and likely not without considerable risk to taxpayers, dislocation, and duplication.
Part of the analytical challenge lies in determining what specific problem creating a public bank is supposed to solve. Is the problem a lack of private investment and access to low-cost financing in support of New Jersey infrastructure, small businesses, and student loans? Is it that private banks are somehow ripping off New Jersey’s taxpayers? Is it the need for more budget relief? All of the above?
It’s not at all clear that New Jersey suffers from a lack of private investment and access to low-cost financing to support social and economic policy goals. Unlike North Dakota in the early 20th century, New Jersey is not facing a systemic lack of liquidity or a credit crunch, agrarian or otherwise. Further, New Jersey benefits from its ready access to the world’s most sophisticated and efficient financial markets. Finally, and most important, the state already maintains a comprehensive range of economic development, infrastructure finance, housing finance, and student assistance programs. New Jersey’s Economic Development Authority (EDA), Housing and Mortgage Finance Agency (HMFA), Educational Facilities Authority (HFA), Environmental Infrastructure Trust (EIT), Transportation Trust Fund Authority (TTFA), and Higher Education Student Assistance Authority (HESAA) — a partial list — are all in the business of financing and/or extending credit to “support billions of dollars of critical investments in infrastructure, small businesses, and student loans.”
The issue of risk
This leads to the larger question of risk. As a practical matter, a more aggressive orientation toward lending in support of worthy social objectives, such as lending to small businesses in economically depressed areas, would, by definition, come at the price of much higher risk to taxpayers. In this context, we need to remember that a public bank would be lending the state’s operating cash balances — we’re not talking about an enormous pool of unused, unencumbered cash — and that any repayment shortfalls or liquidity restrictions could potentially impact the availability of funds for employee salaries and other regular operating expenses.
Managing these and other risks will demand superior managers. Are we confident that a public bank subject to New Jersey state government’s requirements regarding recruitment, compensation, oversight, and procurement would attract and retain the necessary talent?
Are private banks ripping off New Jersey’s taxpayers? The short answer is “no.” True, Wall Street and foreign banks are free to take New Jersey taxpayers’ money out of state because there is no requirement that the state’s cash be “reinvested” in New Jersey specifically. But let’s not forget that the state receives interest on its deposits in private banks, and those banks pay New Jersey taxes. Of course, a public bank would also pay interest — a bit of a mindbender, since the state would in effect be paying itself — but the BND example suggests that it would pay about 25 percent less than private banks, a gap that could take on real significance in a rising interest rate environment. Crucially, a state-owned nonprofit entity would pay no taxes to New Jersey.
What about budget relief? Public banking proponents note that the BND has routinely transferred money to help close North Dakota’s budget deficits. Yet there are several reasons why a public bank is unlikely to emerge as New Jersey’s long-sought golden goose. First, transfers from the BND have been modest, averaging just 0.75 percent of annual state expenditures from 1971 to 2009. Second, the reported amounts transferred do not take into account the reduced interest income on deposits and the foregone tax revenue from private banks. Finally, it takes money to make money and it is highly unlikely that, on a relative basis, a New Jersey public bank will have the same capitalization and thus even the modest money-making potential as its counterpart in North Dakota.
Adding to New Jersey’s crushing debt?
Unless the State were willing to capitalize it with bond proceeds — adding to New Jersey’s already crushing debt — the public bank would rely on deposits of state revenues. That may sound promising, but the fact is that the state doesn’t have a huge, static amount of unencumbered cash lying around in Wall Street and foreign bank deposits. For example, as of the end of June 2016, the Office of Management and Budget had about $500 million on deposit and the Division of Investment’s Cash Management Fund had approximately $1.3 billion in state funds in certificates of deposits (CDs). Using this money to capitalize a public bank would be a challenge. The balances fluctuate significantly throughout the fiscal year and, remember, these are operating funds that must remain liquid and readily accessible to meet the state’s bills. In the end, a public bank capitalized with state deposits is likely to be extremely small scale and thus unlikely, even assuming superb management, to deliver anything more than a very minor or symbolic boost to the state budget.
Of course, there is no guarantee that a public bank would make a profit. It’s worth repeating here that the bank’s deposits would insured only by the “full faith and credit” of the state of New Jersey — with a credit rating already under stress — not the FDIC. That leaves taxpayers on the hook. The risk is real: according to a Federal Reserve Bank of Boston report, the BND’s poor performance in the 1980s exacerbated North Dakota’s fiscal stress. Moreover, the BND’s contribution has varied considerably over the years, sometimes in ways that suggest troubling New Jersey-style political influence over financial policy decisions. More risk.
What are the potential negative impacts upon New Jersey’s private sector? There are two main areas of concern. First, creating the new public bank would involve a disruptive transfer of deposited funds from private banks. No matter how you manage it, disgorging $1.8 billion in deposits would force the state’s former depository banks to adjust their loan portfolios and capitalization to meet regulatory requirements. Although the current proposal is vague as to the role of local government funds, it should be noted that the disruption would be exponentially more severe if the roughly $20 billion in county, municipal, and local school district funds currently held by New Jersey’s 113 Governmental Unit Deposit Protection Act (GUPDA) certified depositories were redirected to capitalize a public bank. About 70 percent of those depositories are New Jersey financial institutions.
Second, no soundly managed public bank would or could limit its lending to borrowers who can’t qualify for a private bank loan. Thus, even if the bulk of its lending activity was participatory, a new public bank would inevitably compete against New Jersey’s private banks for routine business. Although competition isn’t necessarily a bad thing, a public bank with a government deposit base would arguably enjoy an unfair advantage. At any scale, a redirection of deposits and/or subsidized competition would result in job losses. We may love to hate bankers, but lots of our neighbors work in banking, both in New Jersey and on Wall Street.
Is the BND experience pertinent to New Jersey? Not really. The BND may be worthy of respect, but its usefulness as a model for New Jersey or other states in the 21st century is limited.
No offense, but North Dakota is not New Jersey. The differences extend beyond the obvious, with respect to population, infrastructure, and economic base. A reflection of North Dakota’s unique economic, cultural, and political history, the BND was created in response to a specific set of conditions at a specific point in time — conditions that New Jersey simply does not face today. Moreover, having evolved in tandem with the BND, the structure of North Dakota’s modern banking system is fundamentally different from New Jersey’s.
But most significantly, as noted above, today’s BND performs functions that are already being performed by New Jersey government agencies. This begs an obvious question: would a public bank supplement or supplant New Jersey’s veritable “alphabet soup” of institutions offering “public banking” programs and services?
In sum, the idea of creating a New Jersey public bank may be bold, but it is hardly innovative. Even under the most optimistic assumptions, a public bank’s potential benefits would be marginal and come at a high risk to taxpayers and our state’s private sector. Instead of pursuing a “back to the future” idea for creating yet another government agency, New Jersey should focus on the larger and more difficult task of reforming and improving its existing public banking institutions and programs.