A public bank would be bad for Californians

Under a new law signed by Gov. Gavin Newsom, California is doing a market analysis of a state-backed program to give Californians a public option for banking services. In its messaging, lawmakers emphasized that a state-run bank would help those underserved by other banks — namely the “underbanked.”

The problem with this logic is that neobanks already offer services targeting the underbanked. They’ve focused on making it easy to sign up for an account while also staying compliant with federal regulations. Ten years ago, this idea may have been a novel one, but it is outdated and presupposes that people who don’t trust private banks will trust a government-run bank. Would undocumented immigrants really trust the state of California to store their money and not, for example, comply with a federal order to turn over their identity information and potentially seize their assets?

Instead, the real reason for chartering a state-run bank may be populist backlash against large “too big to fail” banks, particularly in the wake of the 2008 financial crisis and subsequent bailouts. Or it may be to allow businesses that cannot use national and international banks — like marijuana dispensaries — to have access to capital, accept card payments, etc.

People should be skeptical. They should be asking questions. Can a state offer the same security and stability as a federally regulated bank? Will there be Federal Deposit Insurance Corp. coverage, or something similar? If, for some reason, this bank needs a bailout, are we sure the federal government will provide one? Keep in mind that only the federal government has the power to borrow money indefinitely.

The federal government has been mulling over the idea of post office banking for decades, although the angle there seems to be different. It is usually a backdoor way of revitalizing the U.S. Postal Service by taking advantage of its existing retail footprint and labor force.

While retail banking with branches is a segment that neobanks do not address directly, the state of California also has little existing infrastructure to utilize for offering retail banking.

People joke about using the department of motor vehicles for banking. Its customer service history is an obvious punchline. But it also has the largest footprint of any state-run retail operation and is staffed with customer service agents. However, with only 180 field offices, it does not have close to the breadth of locations required to offer retail banking services. Even the more than 1,600 U.S. post offices in California are often less convenient than a local bank branch. Would California end up offering a branchless neobank backed by the full faith and credit of the state?

One of the notable financial experiences that many residents in the state share is dealing with the California Employment Development Department, the state agency responsible for disbursing unemployment insurance benefits.

While the department did see an unprecedented increase in unemployment benefits claims during the pandemic, it also experienced more than $11 billion in fraud and people waiting on hold for hours desperate to get money to which they were entitled. In an attempt to mitigate fraud, the state implemented additional ID verification measures that further delayed legitimate claimants. Obviously, this was not a typical time. But it does reflect how a government agency operates during a crisis, and should give consumers pause as they think about how a state-run bank would react to a financial crisis.

Californians may also want to look at the management of California’s state pension funds, the California Public Employees Retirement System (CalPERS) and the California State Teachers’ Retirement System (CalSTRS.)

Aggressive overestimation of returns — which in turn prompted generous benefits — led to severe unfunded liabilities. In 1990, the governor removed money from the pension fund to fill a budget deficit. And because of massive shortfalls in projected returns to the pension fund, as of 2016, the state has had to contribute over $45 billion in taxpayer dollars to deal with unfunded liabilities.

The advantage that both pension funds have is that they are not obligated to directly invest in California’s economy. However, the state bank’s function would be to specifically invest in California projects, likely in pet projects that are politically advantageous. While some may argue that is a legitimate use of a state-run bank, it also greatly increases the bank’s risk exposure because negative economic events tend to occur at the same time and in the same region. The U.S. government has many instruments to cushion the blow that a state bank will not.

The current banking system is useful because it’s adversarial. We can expect state attorneys general to fight on their constituents’ behalf with privately owned banks — or even the federal government. But having one entity responsible for both enforcing rules and running the bank will be problematic.