Sunday, May 03, 2009

50% not-for-profit Public banks as a solution to the credit crisis

While bailing out private banks with public money has so far prevented a crisis turning into another Great Depression it does not seem to have restored a flow of credit sufficient to end the recession.

This may be partly because banks have over-reacted by going from being too lax in giving out credit to almost anyone on generous terms to refusing bridging loans to viable businesses and loan applicants; and partly due to the inevitable cycle of boom and bust in a market that’s been deregulated too much.

It may also be partly the result of self-fulfilling prophecies, with the widespread belief that economic disaster was inevitable resulting in a real economic collapse.

However it’s also because private banks do not have the confidence of shareholders or savers and so fear providing much new credit in case that makes stock market traders decide to target them. This is exacerbated by futures trading and hedge funds, both of which basically allow investment firms to gamble on whether the value of a commodity or a company’s shares will rise or fall in future. So if they for instance decide to target a particular bank they can buy shares in it, sell them cheaply, making a loss on that transaction, while simultaneously having bet through futures trading that the share value of that bank will fall sharply – and make a huge profit on this second transaction.

The only institutions which do retain the full confidence of the markets are governments, which retain creditworthiness and a virtually infinite supply of capital from tax revenues and loans.

So why work through the banks as middle-men when it’s not working? Why not have public banks, accepting savings account deposits and providing loans? There would be no need to nationalise any existing private banks. Governments already own public buildings and already have a supply of capital. They would only have to advertise for staff to run public banks – and with the private banks laying off many employees there will be no shortage of applicants.

There are at least two possible counter-arguments. First public banks, having funding from taxation, might put all private banks out of business. Second a public bank might risk control of the entire credit system and so the entire economy by one party in government or one prime minister and their clients, much as in many former Soviet republics.

One simple solution would be to have public banks operating alongside existing private banks and on a different model. Private banks make all loans on a for-profit basis, but public banks don’t have to do so. A public bank could be required to make half its loans not-for-profit ones which provide social or environmental benefits to the whole community. The rest of its loans would be for-profit ones, the profits from which would fund the social loans. Any surplus could go on further public spending or on reducing taxes on people on low incomes.

By requiring public banks to fund all social loans from for-profit loans in each financial year a replay of the credit crisis, this time among public banks, could be avoided. It would make it un-necessary to try to get private banks and other private lending institutions to make a certain proportion of social, or non-profit, loans and mortgage deals, as the Clinton administration did with legislation requiring many American lending firms to provide social mortgages and loans to people who were too poor ever to be likely to be able to repay them. The attempt to present these unprofitable loans and mortgages as potentially profitable was one of the causes of the current crisis – the so-called ‘toxic debts’. (1)

This was not the only cause of the credit crisis – deregulation by governments (lobbied by banks) also played it’s part along with commissions for mortgage brokers.

NYT 30 Sep 1999 ‘Fannie Mae Eases Credit To Aid Mortgage Lending’,

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