Everything old is new again, it seems. My most recent column covers an idea of a government “job guarantee” that has faded into popular consciousness since the 1940s. Now Senator Kirsten Gillibrand (D., NY) wants to use the US Postal Service compete with retail lenders, another idea that resurfaces periodically.
The UK introduced the idea postal banking in the 1860s, and the idea spread to Japan and the Netherlands in the 1870s and 1880s. American post offices offered deposit services from 1911 to 1967, in part because many newcomers to Europe were used to it in their home countries and were wary of the crisis-prone US financial system. Not surprisingly, the United States Postal Savings System was particularly popular during the Great Depression.
Once the rationing of World War II ended, however, and people got used to the idea of insured deposits, the Post lost its appeal as a bank. Deposits peaked in 1947, and the government eventually withdrew from the business. (Wags would later observe that despite this, the Post still sells savings vehicles indexed to inflation. in the form of eternal stamps.)
Half a century later, some now think ending postal banking was a mistake. Three arguments support this point of view:
* Checking accounts are necessary to participate in modern society, but can be prohibitive for the poor. The Post could offer a “public option” for basic deposit services to reach the “unbanked” or “under-banked”.
* The Post is expected to add revenue streams to help cover its retirement deficit.
* The Post should provide subsidized credit to the poor.
Gillibrand’s proposal includes the three elements. The first is convincing, the second is a non sequitur and the third is silly.
Banks derive most of their income by borrowing at lower rates than they lend. Part of this spread stems from the differences between short-term and long-term interest rates. Part of the variance stems from the fact that a bank loan portfolio tends to be more secure than a typical bank loan. But banks are also reducing their effective borrowing costs more insidiously.
One approach is to exploit the laziness of customers. Currently, short-term risk-free interest rates in the United States are about 1.7%, but even the most profitable current account of the big four banks (
Bank of America
) pays only 0.06%. The big banks are therefore gaining huge spreads despite zero credit risk and zero duration risk.
More importantly, banks only exist in their current form because they have significant government support. Loans to households and businesses sometimes lose money. Funding most of these exposures with overnight borrowings (deposits and deposit-like instruments) is dangerous. Bank creditors, simply suspecting the possibility that they will not be repaid in full, may refuse to roll over the loans, which would force the bank to sell assets to find the money needed to cover the repayment. This inherent mismatch between the assets and liabilities of banks makes them vulnerable to crises.
In the past, banks tried to avoid crises by financing much of their loans with shareholder capital and holding gold reserves to help cover the risk of deposit flight. Equity now represents a tiny fraction of total assets. Post-crisis rules pushed banks to hold more safe assets than before 2008, but not necessarily enough to overcome them in a crisis.
The modern banking model works because the public sector supports private risk-takers: the government-backed central bank is ready to offer cheap loans to private banks when they need to find short-term liquidity, while The government guaranteed deposit insurance system makes bank creditors less discriminatory than they would otherwise be. There are also “implied” guarantees for other forms of bank debt beyond insured deposits.
All of this government support is a transfer from the rest of society to the banking sector. The exact value of this transfer is impossible to determine but some estimates imply that it is worth the effort. at least as much than the aggregate profits of the big banks. Economists and finance scholars from all political backgrounds have called for the elimination of these transfers since the 30s. The simplest approach would be for the central bank to offer deposit and payment services directly to every citizen, but the idea of administering a “public option” for basic banking services through the postal service would be a reasonable compromise. .
It would defeat the purpose, however, if this basic banking operation became a profit center for the Post. While there is a surprisingly intense debate over the causes of the system’s pension deficit, the answer to this question should not affect the decision to restore postal banking. The point of having the postal service as part of the government is that it provides public goods.
The basic service of the USPS is to move mail and packages across the country. If it focused only on what makes money, it would charge different rates depending on the locations it needed to reach, or simply refuse to offer delivery and pickup in large areas of the United States. Likewise, if the problem with today’s banking system is that it depends on opaque government subsidies, the solution is not to transfer some of those subsidies to the postal service but to return them to the citizens.
The most controversial part of Gillibrand’s proposal is that “postal banks would be able to distribute loans to borrowers of up to $ 1,000 at an interest rate slightly higher than the yield on one-month treasury bills.” The explicit idea is to undermine payday lenders, that charge triple-digit annual interest rates in addition to origination fees, but this would also likely impact credit card usage. The result would be a massive misallocation of credit and serious losses to the postal system.
It is difficult to get reliable data on the profitability of payday lenders. Some have concluded that they are not particularly profitable and that usurious interest and charges are needed to offset origination costs and extreme default rates. After all, there is no reason to go to a payday lender unless you have exceptionally bad credit risk. Credit cards are cheaper and more flexible, while personal loans offered online are another alternative.
Only the worst credits go to payday lenders. The Federal Deposit Insurance Corp., for example, found that “fixed operating costs and high loan loss rates justify much of the high APR applied to payday loans” since “the average ratio of pre-tax income to total income in our sample is 11.2%. ” Further study found that “for pure payday lenders, the average profit margin was 3.57%,” although payday lenders who also had pawn shops were slightly more profitable.
These studies were done over 10 years ago and also found that a significant cost to payday lenders came from physical storefronts, staff, and advertising. A more recent study corroborated previous findings regarding the low profitability of payday loans, but argued that bad debt write-off rates were not unusually high compared to credit cards. Instead, the biggest cost to the business comes from finding clients and making tons of small loans. This same study found that the annual “break-even” percentage rate applied to payday loans exceeded 250%.
The USPS already pays a portion of the fixed costs associated with payday loans, so there may be room to offer lower interest rates without losing money. The post inspector general thought he could turn a profit with interest rate as low as 28%, although that seems small compared to the additional risks and origination costs compared to credit cards.
Put it all together, and there’s good reason the U.S. Postal Service is going back to its roots and offering basic banking products like checking accounts at low cost. However, there is no reason to think that it should start offering payday loans at the Treasury bill rate, especially if the goal is to prevent the system from losing more money.