The current for-profit banking system is not ideal for serving some areas of our public life. In the last blog entry (link), I offered two instances, Jack Bogle’s Vanguard Group and Andrew Carnegie’s founding of TIAA-CREF, where not-for- profit structures served dramatically better than their for-profit cousins. Indeed, what I am calling “better” can be measured in billions of dollars that ended up in clients’ pockets rather than the coffers of those providing the service.
One area that would benefit from a not-for-profit structure is municipal finance. The basic idea being that states, towns, cities, and various municipal entities need to borrow money, which they do through an underwriting process controlled by investment banks. Those investment banks, Wall Street if you will, exist in an extreme for-profit environment. And a great deal of profit is made by underwriting these municipal bonds.
Even if Wall Street stuck to creating plain vanilla municipal bonds, the profit extracted is a tremendous flow of money away from towns and cities and into bankers’ pockets. But the story becomes much worse than that. High Finance, as is its habit, has frequently persuaded municipal decision-makers to forgo plain vanilla in favor of far more complex financing deals. Almost invariably, such schemes have worked to the advantage of Wall Street and to the grave disadvantage of the less sophisticated municipal borrowers. As is typical with the problem of asymmetries of information, the guys who know the most tend to take advantage of those who know less. In the case of municipal finance, that asymmetry is dramatic. The bankers know all about the nooks and crannies, potholes and fire swamps of finance. Lots of towns and cities, however, do not. The result is deals that lopsidedly favor Wall Street. The more complex the transaction, the more this is true.
Take, for example, Alabama’s Jefferson County, home to Birmingham, the state’s largest city. In November 2011, the county declared bankruptcy after failing to successfully restructure its $5 billion debt. As the New York Times reported, “JPMorgan Chase… persuaded the county to agree to a bond deal with terms that included complicated interest-rate swaps. Those swaps blew up during the financial crisis of 2008, leaving the county with even more debt than it had started with.” Instead of sticking with straightforward financing, Jefferson County ventured into more risky arrangements and ended up getting the short end of the stick. And they are not alone. Other municipalities that have recently declared bankruptcy include Harrisburg, Penn., Vallejo, Calif., and Central Falls, R.I. Not to mention the largest municipal bankruptcy ever, in 1994, in Orange County, California, that resulted from heavy borrowing and risky investments by its county treasurer. It could be argued that financially anxious municipal officers were persuaded –or tricked- into become gamblers with public funds.
As the word commonwealth suggests, money belonging to municipalities is really for the benefit of everyone who lives there. It is the common wealth, shared by all. Society cannot afford to have great chunks of it spirited away by financial intermediaries. The public good would be greatly served by the creation of a not-for-profit alternative to which towns and cities could turn for their municipal financing needs. It would presumably stick to plain vanilla financing. Such an entity would relieve municipalities of a great burden while keeping lots of extra money available for services they provide to their citizens.
How could such a non-profit bank come into being? The donation of capital and expertise is needed for this real and permanent good. The call is for one or more wealthy and patriotic investors in the public wellbeing to step forward and create such a bank. As was true with Bogle’s Vanguard and Carnegie’s TIAA-CREF, though, much is being asked because it is a gift that might have brought the donor billions. Thus is something more than capital and expertise required. The secret extra ingredient is heroism. All that stands between the current woes and the establishment of such a not-for-profit investment bank is a patriotic hero to step forward and make it a reality.