Thou know’st that all my fortunes are at sea;
Neither have I money nor commodity
To raise a present sum: therefore go forth;
Try what my credit can in Venice do
Antonio, The Merchant of Venice
Sovereign borrowing from powerful banks is centuries old. Venice was the Wall Street of the early Renaissance. The banks located in the watery grandeur there loaned money to faraway kings and traders. Kings didn’t regulate banks but they did often force repayment by raising an army.
Our government reaches far beyond the actions of kings, who merely wanted their money back, and attempts to regulate banks. The government borrows and it oversees. It’s a big effort as the new financial reform law, Dodd-Frank, more strictly regulates the capital adequacy of banks and enforces “fair dealing” and transparency. Reining in the practices of banks and securities firms is hard work but it’s vital to protect our public institutions, taxpayers and investors. Well regulated banks and the rule of law cancels the need for armies to be raised to have a functional financial system.
Cities and states use banks to raise money to build schools and sewer systems. This is primarily done through the municipal bond market which is becoming a well regulated area of the financial system.
Increasingly, though, public entities are borrowing directly from the banks in lieu of issuing bonds. New Jersey and California recently took out multi-billion dollar loans from banks instead of using the debt markets. This illustrates how powerful the banks are that they are big enough to lend to state as big as California. The problem is that this is done in the dark with no requirement for disclosure or fair dealing by the banks. The practice of direct lending by banks is running ahead of the law. And it poses two problems.