New Jersey Gov. Phil Murphy and some supportive state legislators are promoting the idea to establish a bank owned by the state, holding the state’s deposits and making loans considered politically popular. Is this controversial proposal a good idea?  It’s certainly not a new one.

In the 19th century, banks with majority ownership by the states were set up by Alabama, Georgia, Illinois, Indiana, Kentucky, Missouri, South Carolina, Tennessee, Vermont and Virginia. None of these has survived. An instructive case is the State Bank of Illinois, which “became entangled in public improvement schemes” and went bankrupt in 1842.

“In nearly all states” before the Civil War, report John Thom Holdsworth and Davis Rich Dewey, “provision was made in the charters requiring or permitting the State to subscribe for a portion of the stock of banks when organized.” Among the reasons were that the state “should share in the large profits” which were expected, and “because ownership would place the state in the light of a favored customer when it desired to borrow,” Dewey and Robert Emmert Chaddock note in their State Banking Before the Civil War.

Ay, there’s the rub. Such ideas led a number of states to sell bonds and invest the proceeds in bank stock, hoping the dividends on the stock would cover the interest on the debt. “Every new slave state in the South from Florida to Arkansas established one or more banks and supplied all or nearly all of their capital by a sale of state bonds.”

There is one (and only one) state-owned bank operating today, the Bank of North Dakota. The bank is owned 100 percent by the state and its governing commission is chaired by the governor of the state. Its deposits are not insured by the Federal Deposit Insurance Corporation, but are instead guaranteed by the State of North Dakota, which has bond ratings of AA+/Aa1 (In contrast, New Jersey’s bond ratings are A-/A3.) The bank has total assets of about $7 billion and is thus not a large bank. But it has strong capital and is profitable, the profits helped by being exempt from federal and state income taxes. The Bank of North Dakota was founded in 1919, so is almost a century old.

A less hopeful analogue is the Government Development Bank for Puerto Rico, owned by the Commonwealth of Puerto Rico and designed to operate as an inherent part of the government. It was established in 1942 under the leadership of Rexford Tugwell, the Franklin Roosevelt-appointed governor of the island, an ardent believer in central planning. The Government Development Bank, which had total assets of about $10 billion in 2014, has been publicly determined to be insolvent and will impose large losses on its creditors.

According to a report from the Federal Reserve Bank of Minneapolis, Alexander Hamilton, the father of the federally chartered and 20 percent-government/80 percent privately owned First Bank of the United States, “concluded that a national bank must be shielded from political interference: ‘To attach full confidence to an institution of this nature, it appears to be an essential ingredient in its structure that it shall be under a private not a public direction under the guidance of individual interest, not public policy.’” If this principle applies as well to state-owned banks, how is such a bank to devote itself to politically favored loans?

Would a Bank of New Jersey be likely to resemble more the Bank of North Dakota or the Government Development Bank of Puerto Rico?  Or perhaps the State Bank of Illinois?

Image by sevenMaps7

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