If Southern California Cities Start Public Banks, Taxpayers Should Prepare for Massive Bailouts
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If Southern California Cities Start Public Banks, Taxpayers Should Prepare for Massive Bailouts

Should cities and counties start their own government-owned banks?

Should cities and counties start their own government-owned banks?

Southern California, which has seen Orange County and San Bernardino go bankrupt in recent decades, should be well versed on the significant risks that come with financial mismanagement. Nevertheless, in November, Los Angeles voters will weigh in on whether or not the city should launch a publicly-owned (read taxpayer-backed) bank.

The public banking idea seems especially relevant now, as the U.S. commemorates the tenth anniversary of the 2008 financial crisis, which was caused in part by banking shenanigans. The crisis put the country into a recession and led to Congress passing a controversial $700 billion federal bailout package for financial institutions. And although private banks ultimately repaid their taxpayer-funded bailouts with interest, public hostility toward the big banks and bailouts are totally understandable.

So if we can’t trust private, for-profit banks, why not give public banking a try? As proponents point out, financial firms charge cities and counties a lot in fees and interest. These costs — over $100 million a year for Los Angeles, they argue, could be avoided entirely by bringing banking functions in-house. Advocates also point to the Bank of North Dakota (BND), which is returning large sums to the state treasury each year. But we should be cautious about the example set by BND, the only public bank in the United States. The city of Los Angeles has five times as many people as North Dakota, and a more diversified economy, meaning that an LA public bank would likely be a more complex and present greater financial risk.

Larger public banks in Germany offer cautionary, and more relevant, tales. After World War II, German states created seven “Landesbanken” — state banks. The largest of the Landesbanken, WestLB, was forced into liquidation by the European Commission in 2012 after a series of losses and trading scandals. The German state of North Rhine-Westphalia had partially divested itself of the problem, but taxpayers were still on the hook for a large portion of the $23 billion in financial losses the dying bank produced.

Another major Landesbank, HSH Nordbank, was sold to a group of private equity firms earlier this year after generating massive losses for two state owners. Reuters reported that Hamburg and Schleswig-Holstein expected to lose between 10.8 billion and 14 billion Euros (or in US dollars — $12.6 to $16.3 billion at recent exchange rates) on the crippled banks.

Finally, there’s the case of Bankgesellschaft Berlin, which triggered a financial crisis in the city of Berlin after reporting a 1.6 billion Euro loss for the year 2000. The bank, which was 57 percent-owned by the local government, fell victim to bad real estate deals, some involving political cronies, and ill-conceived investment funds. In these deals, the well-connected investors enjoyed the potential financials upsides, while the downside risks were borne by the bank’s owners — government and citizens.  The city government turned off its water fountains and put multiple cultural renovation projects on hold to bail out the failing bank.

If the German experience doesn’t give public banking advocates pause, there’s a cautionary tale closer to home. Although Orange County did not have a formal public bank in the 1990s, it was forced into Chapter 9 bankruptcy after mismanaging funds entrusted to it by municipalities. The county treasurer used interest rate swaps to juice returns from 1991 to 1993, but Fed rate hikes in 1994 inflicted massive financial losses on the county.

Similarly, the city of San Bernardino recently spent five years in bankruptcy and is still struggling to pay creditors and get back on track.

If Southern California cities want to divorce themselves from major banks, governments can shift more of their banking business to credit unions and other alternative institutions. Or, it can do more business with places like Amalgamated Bank, a union-owned bank which recently transitioned to being a certified “B” corporation,  which has responsibilities to workers, customers, the community and environment.

While public banks might sound like a way to stick it to big banks, it could spell financial ruin for cities — and taxpayers who will get stuck with the bills.

This column originally ran in The Orange County Register.

Marc Joffe

Marc Joffe is a senior policy analyst at Reason Foundation.