This article is part of ourEconomy's 'Preparing for the next crisis' series.
In July, a series of earthquakes hit the US state of California. After a relatively quiet few years, they were a jolting reminder that parts of the region are prone to seismic activity and overdue for the “big one.” So too has the recent announcement of a yield curve inversion (and other poor economic news from around the world) reminded us that we are now overdue for another financial crisis – which have, in the neoliberal era, typically happened on average every ten years.
It has been a little more than ten years since the US financial system imploded in 2008, ushering in the worst economic crisis in 80 years. Globalization, and the interconnectedness of many economies, ensured that the crisis spread rapidly, engulfing much of the world. We often forget now how existential the threat really was. There was genuine fear amongst the world’s political and financial elite that capitalism as they knew it was over. In the end, however, they managed to save the existing system through a series of massive government economic interventions. Specifically, rescuing major financial institutions and pumping trillions of dollars into capital markets. For a great number of people, though, the threat was very real. Millions lost their jobs, their homes, their savings, and their retirement funds. Tens of thousands lost their lives.
Despite the severity of the crisis, very little was subsequently changed in the structure of the American financial system. Already weak regulatory reforms have been systematically picked apart by financial industry lobbyists. Too-big-to-fail banks are now even bigger. Fraud and scandals continue to plague the industry. The shadow banking sector has grown in size and complexity. And the US financial system (and broader economy) is still tightly interwoven with the rest of the world. When the next financial crisis comes – and it will come because, like earthquakes, only the when and how severe is ultimately up for debate – it seems all but inevitable that once again the public will be called upon to step in and bailout the big financial institutions.
There is, however, another option. Instead of panic-driven handouts to corporations and temporary quasi-nationalizations, a plan should be in place for cleanly and transparently taking failing financial corporations into genuine public ownership. Ultimately repurposing them, and shifting their activities away from financialization, speculation, and extraction and towards supporting healthy, prosperous, and equitable local economies as well as a sustainable planet.
The response last time
Back in 2007 and 2008, very few people saw the financial crisis coming. Even fewer had any idea what to do once its true severity was revealed. The US government’s immediate response was to pull out all the stops to save the failing banks. This included providing more than 700 banks with capital injections through the Capital Purchase Program (CPP), part of the Troubled Asset Relief Program (TARP). In return, the government (through the Treasury Department) received preferred securities with limited (or non-existent) voting rights as well as warrants to buy company stock equal to a fraction of the overall government investment. This approach has confounded many experts. At the time, Bo Lundgren, the former Swedish Minister of Fiscal and Financial Affairs who had engineered his own government’s response to the 1990s financial crisis in that country, stated “for me, that is a problem. If you go in with capital, you should have full voting rights.” The government also took a more active role with several companies, essentially nationalizing Freddie Mac, Fannie Mae, AIG, and GMAC (and taking a 36 percent ownership stake in Citigroup).
The US government went out of its way to emphasize the time-limited nature of its interventions into the financial sector. “The government was more interested in exiting these investments promptly than in earning a return,” Steven Davidoff Solomon writes. Ultimately, what the banking industry learned was that there was nothing to fear from the government and everything to gain. All the banks had to do was wait out the initial public outcry, allow the government to retreat from the sector, and get back to business as usual.
As the immediate threat from the financial crisis began to subside, attention in the United States turned to reform, the centerpiece of which was the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. Dodd-Frank was, ultimately, a weak piece of legislation. It made very few structural changes to the financial sector (an amendment to break up the biggest banks was voted down, for instance) and many experts have deemed it insufficient and unlikely to prevent another crisis. In 2012, for instance, Richard Kovacevich, the former CEO of Wells Fargo, commented that “there’s nothing in Dodd-Frank that would have prevented the last financial crisis, nor will it prevent the next crisis.” More recently, Neel Kashkari, President of the Federal Reserve Bank of Minneapolis, has stated that “the biggest banks are still [too-big-to-fail] and continue to pose a significant, ongoing risk to our economy.”
Moreover, since its passage even those reforms that made it into the final legislation have been systematically stalled, blocked, and dismantled. The political influence wielded in Washington by the finance sector is legendary, and Dodd-Frank has been firmly in their cross-hairs for most of the last ten years. In 2014, for instance, Congress repealed the regulation requiring banks to trade certain risky derivatives contracts in separate affiliates with higher capital requirements and no government protection (the so-called “pushout” rule). The repeal was included in a spending bill required to keep the government operating (causing outrage among Congressional Democrats) and was written almost entirely by Citigroup, the bank that received one of the largest shares of government bailout funds during the crisis.
Former IMF chief economist Simon Johnson has recently commented that the reforms enacted after the financial crisis “were serious; but they did not go far enough, and they can be rolled back without much difficulty. The Trump administration is poised to do exactly that. The big banks will get bigger. Capital levels will fall. And reasonable risk-management practices will again become unfashionable. Powerful people do well from booms and busts. The rest of us can expect deeper inequality and more crisis-induced poverty.”
And the big banks have, indeed, increased in size since the financial crisis. “Of the 15 banks that received the most bailout money, 11 are now bigger than they were before the recession, even after adjusting for inflation…” Philip Bump reported in the Washington Post in early 2016. “The recession was a blip on a steep upward climb.” Moreover, repeated scandals and investigations during the past decade suggest that the financial sector has not yet adequately tackled the internal dynamics and incentives that led to the excessive risk taking, speculation, and fraud that was at the heart of the financial crisis. “The last decade has seen a steady stream of financial scandals and crises: mortgage frauds, insider trading, the illegal fixing of global interest rates, money laundering, and the rigging of the Treasury bond market. This is a partial list,” author and former hedge fund analyst Sheelah Kolhatkar wrote in 2016.
Lastly, the shadow banking sector – essentially opaque and un- or under-regulated financial institutions that offer a variety of often risky financial services and instruments – has grown, now accounting for at least $13.8 trillion in assets in 2015, or around 75 percent of the country’s total GDP. The shadow banking sector is intricately entwined with the regulated banking system, raising the prospect of substantial contagion and damage to the rest of the economy when another crisis occurs. “A collapse in the shadow banking sector cannot be contained to the shadow banking sector,” former Comptroller of the Currency Eugene Ludwig warns.
The public ownership alternative
When the next big financial crisis occurs, one or more of the large financial institutions will likely once again become reliant on public support for their survival. In such a moment these companies can be de-privatized rather than simply bailed out. During the 2008 financial crisis, various commentators and experts actually came out in favor of short-term nationalizations (forms of which were implemented in several cases), but were generally emphatic in their rejection of long-term public ownership. For instance, economist Adam Posen stated in 2009 that “nobody in their right mind wants the government to be in the banking business any longer than it needs to be.”
Such offhand judgments, however, deliberately ignore the extensive, and often highly successful, experience with public banking both in the United States and around the world. Recently, Thomas Marois has estimated that there are nearly 700 public banks operating globally with some $37.7 trillion in assets. In Germany, for instance, there are close to 400 publicly owned municipal savings banks (Sparkassen) with more than €1.2 trillion in assets and approximately 210,000 employees. Unlike some of the larger banks, the Sparkassen, according to The Economist, “[came] through the crisis with barely a scratch.” In North Dakota, the publicly owned Bank of North Dakota (BND) just celebrated its 100 year anniversary. The bank, which has $7 billion in assets and a loan portfolio of $4.5 billion, has been widely credited with helping the state weather the last financial crisis by backstopping local banks with liquidity (thereby ensuring that the state had the lowest foreclosure rate and lowest credit card default rate in the country, as well as no bank failures for more than a decade), and making loans to consumers while private banks were freezing credit, all while continuing to contribute its revenues to the state’s budget.
One of the few prominent finance experts who engaged seriously with the question of long-term public ownership during the financial crisis was former Goldman Sachs advisor (now chief economist at Citigroup) Willem Buiter, who wrote in September 2008:
"Is the reality…that large private firms make enormous private profits when the going is good and get bailed out and taken into temporary public ownership when the going gets bad, with the tax payer taking the risk and the losses? If so, then why not keep these activities in permanent public ownership? There is a long-standing argument that there is no real case for private ownership of deposit-taking banking institutions, because these cannot exist safely without a deposit guarantee and/or lender of last resort facilities, that are ultimately underwritten by the taxpayer."
Beyond this, there are several reasons why long-term public ownership in the financial sector can be beneficial. According to Marois, these can include economic and regional development (and specifically, financing public policy priorities such as renewable energy and climate change mitigation), providing financial services to sectors and individuals that are ignored or underserved by the private sector, stabilizing the economy during times of crisis, taking the lead on setting social and environmental standards, generating public revenue to cross-subsidize public services and projects, and operating without the need for profit-maximization (therefore reducing costs for users and helping to “minimize the effect of hyper-competitive global financial imperatives on society”). Public banks could also be restricted from engaging in many of the types of speculative activity that have been driving increased financialization, systemic risk, and economic instability in recent decades.
If and when a public takeover actually occurs, one option is for the new publicly-owned entity to be kept largely intact and tasked to specific large-scale public policy needs and goals, such as investing in badly needed infrastructure improvements or financing the transition to renewable energy (and a just transition for workers and communities affected by the move away from fossil fuels). Another would be to break up the entity into a network of regional and local public banks that could focus on taking deposits from public entities (such as local governments), backstopping small community banks, providing banking services to low-income populations, extending low-interest loans to students, small businesses, and those recovering from disasters, and/or financing the conversion of businesses to worker ownership. Profits would flow to state and local governments, providing a valuable source of revenue to pay for social services, infrastructure, retirement obligations, and other important areas of need.
In either scenario, the internal governance and oversight of the new, publicly owned entities could (and should) be reformed and democratized. This may include using deliberative and participatory processes to set the overall long-term structure and mission of the bank(s); establishing appropriate metrics of success and efficiency for each public bank beyond pure financial measures (such as social and ecological benefit); enabling robust stakeholder participation (in the form of multi-stakeholder boards, worker assemblies, empowered trade unions, and the like); increasing transparency and accountability requirements; and enshrining equity in internal governance procedures (such as limiting executive pay, increasing racial and gender diversity, and gender pay equality).
Planning for next time
Bailing out Wall Street and the big financial corporations was unpopular ten years ago, and has only become more unpalatable since. One poll in 2012 found that 84 percent of Americans opposed any future bank bailouts (an extraordinary number given that these days you would be hard pressed to find any issue that nearly 90 percent of all Americans can agree on). In fact, there are indications that Americans actually prefer public ownership to bailouts. A 2009 Newsweek poll, for instance, found that 56 percent of Americans thought it better to have “nationalization, where the government takes temporary control” versus 29 percent who thought “government financial aid without any government control of the bank” was better. Similar sentiment also exists in the UK. In 2017, the Legatum Institute, a right-wing think tank, was surprised to find that 50 percent of Britons favoured nationalizing the banks (amidst strong appetite for public ownership more broadly).
Moreover, since the financial crisis ten years ago, interest in public banking has taken off like wildfire across the United States and around the world as activists, community groups, and politicians have begun to recognize the importance and potential of asserting public control over finance. It is likely that during the next crisis, there will be similar (if not greater) public support for public ownership rather than no-strings-attached corporate bailouts. Such sentiments can naturally be deepened into widespread support for longer-term public ownership in the sector if a developed, viable, and vetted plan is available. It is imperative that the hard work of developing such a plan starts now. We simply cannot know how much time we have until the next big crisis hits.
Thomas M. Hanna is Research Director at The Democracy Collaborative, a US based research and development lab for a more democratic economy. He is author of Our Common Wealth: The Return of Public Ownership in the United States. This article is adapted from his 2018 report The Crisis Next Time: Planning for Public Ownership as an Alternative to Corporate Bank Bailouts.