SUBSCRIBE TO OUR FREE NEWSLETTER
Daily news & progressive opinion—funded by the people, not the corporations—delivered straight to your inbox.
5
#000000
#FFFFFF
5
#000000
#FFFFFF
bank of north dakota
It's Time to Change the Rules of the Banking Game
A state-owned bank on the model of the Bank of North Dakota can provide low-interest loans, liquidity, and financial sovereignty.
Mar 26, 2023
On CNN March 14, Roger Altman, a former deputy Treasury secretary in the Clinton administration, said that American banks were on the verge of being nationalized:
What the authorities did over the weekend was absolutely profound. They guaranteed the deposits, all of them, at Silicon Valley Bank. What that really means… is that they have guaranteed the entire deposit base of the U.S. financial system. The entire deposit base. Why? Because you can't guarantee all the deposits in Silicon Valley Bank and then the next day say to the depositors, say, at First Republic, sorry, yours aren't guaranteed. Of course they are.
…So this is a breathtaking step which effectively nationalizes or federalizes the deposit base of the U.S. financial system.
The deposit base of the financial system has not actually been nationalized, but Congress is considering modifications to the Federal Deposit Insurance Corporation (FDIC) insurance limit. Meanwhile, one state that does not face those problems is North Dakota, where its state-owned bank acts as a "mini-Fed" for the state. But first, a closer look at the issues.
Bail In, Bail Out, or "Socialism for the Rich"?
On Friday, March 10, Silicon Valley Bank (SVB) was put into receivership by the FDIC. The FDIC announced that deposits over the $250,000 insurance limit would get an advance dividend within the next week, and would receive a receivership certificate for the rest of the funds. Most of the depositors were venture-backed startups that needed to keep large deposits in the bank to meet payroll and pay suppliers, and over 95% of the deposits were uninsured and at risk of being lost. It was basically a "bail in" of the uninsured deposits, which would be recoverable only if funds were available after the bank's assets had been sold.
But that arrangement lasted only two days. On March 12, Signature Bank was put into receivership; and the FDIC, Treasury, and Federal Reserve jointly announced that all of the deposits at the two banks, not just those under the insurance limit, would be available for withdrawal on demand.
At a Senate Finance Committee hearing on March 16, Treasury Secretary Janet Yellen said that the guarantee would not apply to all deposits at all banks. Rather, the determination would be made on a case-by-case basis.
In a Bloomberg News interview on March 16, former FDIC Chair Sheila Bair criticized that decision. She observed that the two banks getting special treatment were not "systemically important," and that the cost of the expanded guarantee was to be covered by a special assessment against all insured banks, including the small community banks that provide essential credit to local businesses. She argued that if guarantees were going to be given over the $250,000 limit, they should apply to deposits everywhere.
Meanwhile, on March 12, the Federal Reserve announced that it had set up a special purpose vehicle of the sort arranged for Covid relief in March 2020, called the Bank Term Funding Program (BTFP). Like the Covid special purpose vehicles, it would be backstopped with $25 billion from the Exchange Stabilization Fund (ESF), a fund set up in 1934 to stabilize the exchange value of the dollar. The BTFP was to be available to any bank needing it, and many banks obviously did. Over $300 billion in short-term loans were withdrawn from the Fed's various facilities just in the week after SVB's collapse.
This money is not, however, the sort of "free lunch" provided to troubled banks in the last financial crisis. The money is to be advanced as a loan for up to a year, at a hefty interest rate as of March 22 of 4.88%. According to a Federal Reserve press release, advances will be made to "eligible depository institutions pledging U.S. Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral. These assets will be valued at par. The BTFP will be an additional source of liquidity against high-quality securities, eliminating an institution's need to quickly sell those securities in times of stress."
"Valued at par" means that banks can hold their long-term federal securities to maturity while acquiring ready cash against them to meet withdrawals, without having to "mark to market" and sell at a loss.
The Systemic Flaw
So what caused this crisis, and what can be done to remedy it?
In the midst of the 2008 economic crisis, former Fed Chair Alan Greenspan conceded that there was a flaw in his perception of the financial operating system. For 40 years, he had believed that banks could "self-regulate" responsibly, a presumption that had proven to be flawed.
In the case of SVB, however, the bank was not engaged in the sort of risky lending seen in the subprime crisis, and increased "stress testing" wouldn't have saved it. It had put its deposits largely in federal securities, purported to be the safest assets available—so safe that they carry a "zero risk weighting" requiring no extra capital buffer. What went wrong was that they were long-term bonds at low interest. When rates shot up, the market value of the bonds dropped, since buyers prefer newer bonds paying higher interest. Bonds that could be sold were sold at a loss, and some marked "hold to maturity" could not be sold at all. As a result, SVB lacked the liquidity to meet the sudden unexpected demand for withdrawals.
The flaw to which SVB and many other "troubled" banks have fallen victim is the age-old systemic problem of "borrowing short to lend long." For centuries, banks have borrowed the money of depositors who expect to have it available on demand, and have invested it in long-term assets that cannot be immediately liquidated. The system works well so long as the depositors don't panic and rush to pull their money out all at once. But when they do, if the problem is systemic, not just single banks but the whole banking system can collapse.
We used to see this flaw dramatized every December, when TV networks ran the 1946 Christmas classic "It's a Wonderful Life." When the Bailey Brothers Building and Loan suffered a bank run, George Bailey (Jimmy Stewart) had to explain to the panicked depositors that their money had been lent to their neighbors. He was on the verge of suicide, when a guardian angel showed him how critical he and his bank had been to the community; and the neighbors pitched in and rescued the bank.
Even closer to the situation today was the crisis of the savings and loan associations (S&Ls) of the 1980s, after the Federal Reserve raised interest rates dramatically to kill inflation. Most of the assets of the S&Ls were long-term fixed-rate mortgages. As rates rose, they had to pay more to attract deposits; but the amount they earned on their fixed-rate mortgages didn't change. Losses mounted, but the S&L insurance fund, the FSLIC, lacked sufficient money to reimburse all the depositors at failed S&Ls so the regulators turned a blind eye and allowed them to keep operating as "zombies." The matter was finally resolved with legislation in 1989 that placed S&L insurance under the FDIC and established the Resolution Trust Corporation to resolve the remaining troubled S&Ls. The ultimate cost to the taxpayers was estimated to be as high as $124 billion.
As with George Bailey's savings and loan, the flaw was not "fractional reserve" lending. The S&Ls pooled the money of their customers and lent only what they had. The systemic flaw was and still is that to make long-term loans, banks must borrow "other people's money," which is expected to be available on demand. Today the banks' liquidity options include not just their own depositors but other banks' depositors in the fed funds market, and pension funds and other institutional creditors lending in the repo market. But they all expect their money to be available on demand; and if the bank has lent it out in long-term loans, the bank can be caught short shuffling reserves around trying to meet that demand.
The Failed Banks Were Not Nationalized, But Maybe They Should Have Been
One option that was debated in the 2008-09 crisis was actual nationalization. As professor Michael Hudson wrote in February 2009:
Real nationalization occurs when governments act in the public interest to take over private property… Nationalizing the banks along these lines would mean that the government would supply the nation's credit needs. The Treasury would become the source of new money, replacing commercial bank credit. Presumably this credit would be lent out for economically and socially productive purposes, not merely to inflate asset prices while loading down households and business with debt as has occurred under today's commercial bank lending policies.
Gar Alperovitz, professor emeritus at the University of Maryland, also weighed in on the issue. In a 2012 New York Times article titled "Wall Street Is Too Big to Regulate," he noted that the five biggest banks—JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, and Goldman Sachs—had amassed assets amounting to more than half the nation's GDP. He wrote:
With high-paid lobbyists contesting every proposed regulation, it is increasingly clear that big banks can never be effectively controlled as private businesses. If an enterprise (or five of them) is so large and so concentrated that competition and regulation are impossible, the most market-friendly step is to nationalize its functions…
Nationalization isn't as difficult as it sounds. We tend to forget that we… essentially nationalized the American International Group, one of the largest insurance companies in the world, and the government still owns roughly 60 percent of its stock.
Another example was Continental Illinois, the largest bank bankruptcy and the seventh-largest bank in the country when it failed in 1984. The FDIC wiped out existing shareholders, infused capital, took over bad assets, replaced senior management, and owned the bank for about a decade, running it as a commercial enterprise, selling it in 1994.
What constituted a radical departure from capitalist principles in the last financial crisis was not "nationalization" but an unprecedented wave of bank bailouts, sometimes called "welfare for the rich." The taxpayers bore the losses while the culpable management not only escaped civil and criminal penalties but made off with record bonuses. Banks backed by an army of lobbyists succeeded in getting laws changed so that what was formerly criminal behavior became legal. Instead of nationalization, we got TARP, the Troubled Asset Relief Program, in which toxic assets were purchased from financial institutions by the Treasury. Faced with the inequity of that solution, many economists recommended nationalization instead. Willem Buiter, chief economist of Citigroup and formerly a member of the Bank of England's Monetary Policy Committee, wrote in the Financial Times in September 2009:
Is the reality of the modern, transactions-oriented model of financial capitalism indeed 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 taxpayer 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. ...Once the state underwrites the deposits or makes alternative funding available as lender of last resort, deposit-based banking is a license to print money. [Emphasis added.]
Those are all good arguments, but Congress is not likely to nationalize the whole banking system any time soon.
What About Nationalizing the Liquidity Pool?
Without going to those lengths, what could be made a public utility is the banks' liquidity pool. Banks could borrow directly from the deep pocket of the central bank, the "lender of last resort" (or from the Treasury if it were reengineered so that it could issue money as credit without taxing or going into debt). Banks would still need to make "prudent" loans—loans to borrowers who had demonstrated an ability to pay the money back—since if they suffered substantial defaults, they would not be able to balance their books and could be put into bankruptcy. They would still charge interest to cover their costs, and they would still compete for borrowers by keeping their interest rates low, maintaining the principles of "market capitalism" operating now. Customer deposits could be sequestered separately from loans, e.g. at government-backed postal banks. In fact, sequestering customer funds is what brokerages (such as Schwab and Fidelity) do now. Rather than the bank gambling with your money, you gamble with it yourself. But that, of course, can be risky too!
In any case sequestering deposits is not likely to happen either. What is being sought is what Roger Altman predicted—FDIC insurance coverage of the entire deposit base. In a March 17 letter first reported by Bloomberg News, the Midsize Bank Coalition of America called on regulators "immediately... to reinstate full deposit insurance coverage for depositors," for two years. That was done in 2008, the letter noted, "and was one of the most effective tools used in the great financial crisis and it needs to be brought back immediately. Importantly, as happened previously, this increase in insurance should be paid for directly by the banks themselves by simply increasing the deposit insurance assessment on banks who choose to participate in this increased insurance coverage."
The concern for midsize banks is that depositors have been fleeing to giant "too big to fail" banks, perceiving them to be safer. But as Cornell professor Robert Hockett observes, midsize banks lend to the midsize businesses that are the backbone of the productive economy. He has drafted legislation to provide for universal deposit insurance, discussed in Forbes. However, it's an uphill battle. Even Sheila Bair, who is clearly sympathetic to the plight of local banks, has reservations on full coverage. As reported on MSN.com:
FDIC Chairwoman Sheila Bair said Tuesday that Congress should consider temporarily providing guarantees for deposits in transaction accounts used by employers to pay their workers—a move that some Democrats are considering.
But Bair said it would be an "overreaction" to insure all bank deposits.
"Unlimited insurance would be very expensive to do. It would be assessed on the banking system, backstopped by taxpayers, and would primarily help very, very wealthy people," Bair said on Washington Post Live.
Small community banks—defined as banks with $10 billion or less in assets—have spoken out against paying more to cover the failure of larger banks such as SVB.
The Public Bank Option
Meanwhile, one midsize bank that has escaped this furor is the Bank of North Dakota. With assets in 2021 of $10.3 billion and a return on investment of 15%, the BND is owned by the state, which self-insures it. There is no fear of bank runs, because the state's revenues compose the vast majority of its deposits, and they must be deposited in the BND by law.
The state's local banks are also protected by the BND, which is forbidden to compete with them. Instead, it partners with them, helping with liquidity and capitalization. The BND has been called a "mini-Fed" for the state and its banks. That helps explain why North Dakota has more local banks per capita than any other state, at a time when other states have been losing banks to big bank mergers, causing the number of U.S. banks to shrink radically.
U.K. professor Richard Werner recently published a briefing memo supporting the case for a public bank. It was prepared for the state of Tennessee, which is considering a sovereign state bank on the North Dakota model, but the arguments apply to all states. Benefits discussed include dividends, higher state-level tax revenues, greater job creation, greater local autonomy and resilience to shocks, more options for funding public sector borrowing and state pension funds, and protection of financial transaction freedom and privacy.
Small and local is good, but even small regional banks need to pool their resources for maximum efficiency and security. A state-owned bank on the model of the Bank of North Dakota can provide low-interest loans, liquidity, and financial sovereignty, keeping financial resources in the state directed to public purposes, all while turning a profit for the state.
Keep ReadingShow Less
Bank of North Dakota Soars Despite Oil Bust: A Blueprint for California?
May 02, 2016
Despite North Dakota's collapsing oil market, its state-owned bank continues to report record profits. This article looks at what California, with fifty times North Dakota's population, could do following that state's lead.
In November 2014, the Wall Street Journal reported that the Bank of North Dakota (BND), the nation's only state-owned depository bank, was more profitable even than J.P. Morgan Chase and Goldman Sachs. The author attributed this remarkable performance to the state's oil boom; but the boom has now become an oil bust, yet the BND's profits continue to climb. Its 2015 Annual Report, published on April 20th, boasted its most profitable year ever.
The BND has had record profits for the last 12 years, each year outperforming the last. In 2015, it reported $130.7 million in earnings, total assets of $7.4 billion, capital of $749 million, and a return on investment of a whopping 18.1 percent. Its lending portfolio grew by $486 million, a 12.7 percent increase, with growth in all four of its areas of concentration: agriculture, business, residential, and student loans.
By increasing its lending into a collapsing economy, the BND has helped prop the economy up. In 2015, it introduced new infrastructure programs to improve access to medical facilities, remodel or construct new schools, and build new roads and water infrastructure. The Farm Financial Stability Loan was introduced to assist farmers affected by low commodity prices or below-average crop production. The BND also helped fund 300 new businesses.
Those numbers are awe-inspiring, considering that North Dakota has a population of only about 750,000, just half the size of Phoenix or Philadelphia. Compare that to California, the largest state by population, which has more than fifty times as many people as North Dakota.
What could California do with its own bank, following North Dakota's lead? Here are some possibilities, including costs, risks and potential profits.
Getting Started: Forming a Bank Without Cost to the Taxpayers
A bank can be started in California with an initial capitalization of about $20 million. But let's say the state wants to do something substantial and begins with a capitalization of $1 billion.
Where to get this money? One option would be the state's own pension funds, which are always seeking good investments. Today state pension funds are looking for a return of about 7% per year (although in practice they are getting less). One billion dollars could be raised more cheaply with a bond issue, but tapping into the state's own funds would avoid increasing state debt levels.
At a 10% capital requirement, $1 billion in capitalization is sufficient to back $10 billion in new loans, assuming the bank has an equivalent sum in deposits to provide liquidity.
Where to get the deposits? One possibility would be the California Pooled Money Investment Account (PMIA), which contained $67.7 billion earning a modest 0.47% as of the March 31, 2016 quarter. This huge pool of rainy day, slush and investment funds is invested 47.01% in US Treasuries, 16.33% in certificates of deposit and bank notes, 8.35% in time deposits, and 8.91% in loans, along with some other smaller investments. A portion of this money could be transferred to the state-owned bank as its deposit base, on which 0.5% could be paid in interest, generating the same average return that the PMIA is getting now.
For our hypothetical purposes, let's say $11.1 billion is transferred from the PMIA and deposited in the state-owned bank. With a 10% reserve requirement, $1.1 billion would need to be held as reserves. The other $10 billion could be lent or invested. What could be done with this $10 billion? Here are some possibilities.
Slashing the Cost of Infrastructure
One option would be to fund critical infrastructure needs. Today, California and other states deposit their revenues in Wall Street banks at minimal interest, then finance infrastructure construction and repair by borrowing from the Wall Street bond market at much higher interest. A general rule for government bonds is that they double the cost of projects, once interest is paid. California and other states could save these costs simply by being their own bankers and borrowing from themselves; and with their own chartered banks, they could do it while getting the same safeguards they are getting today with their Wall Street deposits and investments. The money might actually be safer in their own banks, which would not be subject to the bail-in provisions now imposed by the G-20's Financial Stability Board on giant "systemically risky" banking institutions.
To envision the possibilities, let's say California decided to fund its new bullet train through its state-owned bank. In 2008, Californians approved a bond issue of $10 billion as the initial outlay for this train, which was to run from Los Angeles to San Francisco. At then-existing interest rates, estimates were that by the time the bonds were paid off, California taxpayers would have paid an additional $9.5 billion in interest.
So let's assume the $10 billion in available assets from the state-owned bank were used to repurchase these bonds. The state would have saved $9.5 billion, less the cost of funds.
It is not clear from the above-cited source what the length of the bond issue was, but assume it was for 20 years, making the interest rate about 3.5%. The cost of one billion dollars in capital for 20 years at 7% would be $2.87 billion, and the cost of $11.1 billion in deposits at 0.5% would be $1.164 billion. So the total cost of funds would be $4.034 billion. Deducted from $9.5 billion, that leaves about $5.5 billion in savings or profit over 20 years. That's $5.5 billion generated with money the state already has sitting idle, requiring no additional borrowing or taxpayer funds.
What about risk? What if one of the cities or state agencies whose money is held in the investment pool wants to pull that money out? Since it is held in the bank as deposits, it would be immediately liquid and available, as all deposits are. And if the bank then lacked sufficient liquidity to back its assets (in this case the repurchase of its own bonds), it could in the short term do as all banks do - borrow from other banks at the Fed funds rate of about 0.35%, or from the Federal Reserve Discount Window at about 0.75%. Better yet, it could simply liquidate some of the $56 billion remaining in the PMIA and deposit that money into its state bank, where the funds would continue to earn 0.5% interest as they are doing now.
Assume that from its $5.5 billion in profits, the bank then repaid the pension funds their $1 billion initial capital investment. That would leave $4.5 billion in profit, free and clear - a tidy sum potentially generated by one man sitting in an office shuffling computer entries, without new buildings, tellers, loan officers or other overhead. That capital base would be sufficient to capitalize about $40 billion in new loans, all generated without cost to the taxpayers.
A California New Deal
The bullet train example is a simple way to illustrate the potential of a state-owned bank, but there are many other possibilities for using its available assets. As the BND did after building up its capital base, the bank could advance loans at reasonable rates for local businesses, homeowners, students, school districts, and municipalities seeking funds for infrastructure.
These loans would be somewhat riskier than buying back the state's own bonds, and they would involve variable time frames. Like all banks, the state bank could run into liquidity problems from borrowing short to lend long, should the depositors unexpectedly come for their money. But again, that problem could be fixed simply by liquidating some portion of the money remaining in the PMIA and depositing it in the state-owned bank, where it would earn the same 0.5% interest it is earning now.
Here is another intriguing possibility for avoiding liquidity problems. The bank could serve simply as intermediator, generating loans which would then be sold to investors. That is what banks do today when they securitize mortgages and sell them off. Risk of loss is imposed on the investors, who also get the payment stream; but the bank profits as well, by receiving fees for its intermediating functions.
The federally-owned Reconstruction Finance Corporation (RFC) did something similar when it funded a major portion of the New Deal and World War II by selling bonds. This money was then used for loans to build infrastructure of every sort and to finance the war. According to a US Treasury report titled Final Report of the Reconstruction Finance Corporation (Government Printing Office, 1959), the RFC loaned or invested more than $40 billion from 1932 to 1957 (the years of its operation). By some estimates, the sum was about $50 billion. A small part of this came from its initial capitalization. The rest was borrowed - $51.3 billion from the US Treasury and $3.1 billion from the public. The RFC financed roads, bridges, dams, post offices, universities, electrical power, mortgages, farms, and much more, while at the same time making money for the government. On its normal lending functions (omitting such things as extraordinary grants for wartime), it wound up earning a total net income of $690 million.
North Dakota has led the way in demonstrating how a state can jump-start a flagging economy by keeping its revenues in its own state-owned bank, using them to generate credit for the state and its citizens, bypassing the tourniquet on the free flow of credit imposed by private out-of-state banks. California and other states could do the same. They could create jobs, restore home ownership, rebuild infrastructure, and generally stimulate their economies while generating hefty dividends for the state without increasing debt levels or risking public funds - and without costing taxpayers a dime.
Keep ReadingShow Less
Most Popular