The recent proposal to vote with our feet by shifting our deposits from Wall Street to community banks is a great start. However, community banks are not suffering from a lack of deposits so much as from a lack of the capital they need to make new loans, and investment capital today is scarce. There is a way out of this dilemma, demonstrated for over 90 years by the innovative state of North Dakota -- a partnership in which community banks are backed by the deep pockets of a state-owned bank.
Our fearless editor and leader Arianna Huffington just posted an article that has sparked a remarkable wave of interest, evoking nearly 5,000 comments in less than a week. Called "Move Your Money," the article maintains that we can get credit flowing again on Main Street by moving our money out of the Wall Street behemoths and into our local community banks. This solution has been suggested before, but Arianna added the very appealing draw of a video clip featuring Jimmy Stewart in It's a Wonderful Life. In the holiday season, we are all hungry for a glimpse of that wonderful movie that used to be a mainstay of Christmas, showing daily throughout the holidays. The copyright holders have suddenly gotten very Scrooge-like and are allowing it to be shown only once a year on NBC. Whatever their motives, Wall Street no doubt approves of this restriction, since the movie continually reminded viewers of the potentially villainous nature of Big Banking.
Pulling our money out of Wall Street and putting it into our local community banks is an idea with definite popular appeal. Unfortunately, however, this move alone won't be sufficient to strengthen the small banks. Community banks lack capital -- money that belongs to the bank -- and the deposits of customers don't count as capital. Rather, they represent liabilities of the bank, since the money has to be available for the depositors on demand. Bank "capital" is the money paid in by investors plus accumulated retained earnings. It is the net worth of the bank, or assets minus liabilities. Lending ability is limited by a bank's assets, not its deposits; and today, investors willing to build up the asset base of small community banks are scarce, due to the banks' increasing propensity to go bankrupt.
It's a Wonderful Life actually illustrated the weakness of local community banking without major capital backup. George Bailey's bank was a savings and loan, which lent out the deposits of its customers. It "borrowed short and lent long," meaning it took in short-term deposits and made long-term mortgage loans with them. When the customers panicked and all came for their deposits at once, the money was not to be had. George's neighbors and family saved the day by raiding their cookie jars, but that miracle cannot be counted on outside Hollywood.
The savings and loan model collapsed completely in the 1980s. Since then, all banks have been allowed to create credit as needed just by writing it as loans on their books, a system called "fractional reserve" lending. Banks can do this up to a certain limit, which used to be capped by a "reserve requirement" of 10%. That meant the bank had to have on hand a sum equal to 10% of its deposits, either in its vault as cash or in the bank's reserve account at its local Federal Reserve bank. But many exceptions were carved out of the rule, and the banks devised ways to get around it.
That was when the Bank for International Settlements stepped in and imposed "capital requirements." The BIS is the "central bankers' central bank" in Basel, Switzerland. In 1988, its Basel Committee on Banking Supervision published a set of minimal requirements for banks, called Basel I. No longer would "reserves" in the form of other people's deposits be sufficient to cover loan losses. The Committee said that loans had to be classified according to risk, and that the banks had to maintain real capital - their own money - generally equal to 8% of these "risk-weighted" assets. Half of this had to be "Tier 1" capital, completely liquid assets in the form of equity owned by shareholders -- funds paid in by investors plus retained earnings. The other half could include such things as unencumbered real estate and loans, but they still had to be the bank's own assets, not the depositors'.
For a number of years, U.S. banks managed to get around this rule too. They did it by removing loans from their books, bundling them up as "securities," and selling them off to investors. But when the "shadow lenders" - the investors buying the bundled loans - realized these securities were far more risky than alleged, they exited the market; and they aren't expected to return any time soon. That means banks are now stuck with their loans; and if the loans go into default, as many are doing, the assets of the banks must be marked down. The banks can then become "zombie banks" (unable to make new loans) or can go bankrupt and have to close their doors.
The final blow to the easy credit provided by U.S. banks came with another stricture on capital, called Basel II. It manifested in the U.S. as the "mark-to-market" rule, which required a bank's loan portfolio to be valued at what it could be sold for (the "market"), not its original book value. In today's unfavorable market, that meant a huge drop in asset value for the banks, dramatically reducing their ability to generate new loans. When the announcement was made in November 2007 that this rule was going to be imposed on U.S. banks, credit dried up and the stock market plunged. The market did not begin to recover until 2009, when the rule was largely lifted. However, on December 17, 2009, the Basel Committee announced plans to impose even tighter capital requirements. The foreseeable result is the collapse of yet more community banks and the drying up of yet more credit on Main Street.
Where can our floundering community banks get the capital to make room on their books for substantial new loans? An innovative answer is provided by the state of North Dakota, one of only two states (along with Montana) expected to meet its budget in 2010. North Dakota was also the only state to actually gain jobs in 2009 while other states were losing them. Since 2000, North Dakota's GNP has grown 56 percent, personal income has grown 43 percent and wages have grown 34 percent. The state not only has no funding problems, but in 2009 it had a budget surplus of $1.3 billion, the largest it ever had -- not bad for a state of only 700,000 people.
North Dakota is the only state in the union to own its own bank. The Bank of North Dakota (BND) was established by the state legislature in 1919 specifically to free farmers and small businessmen from the clutches of out-of-state bankers and railroad men. Its populist organizers originally conceived of the bank as a credit union-like institution that would provide an alternative to predatory lenders, but conservative interests later took control and suppressed these commercial lending functions. The BND now chiefly acts as a central bank, with functions similar to those of a branch of the Federal Reserve.
However, the BND differs from the Federal Reserve in significant ways. The stock of the branches of the Fed is 100% privately owned by banks. The BND is 100% owned by the state, and it is required to operate in the interest of the public. Its stated mission is to deliver sound financial services that promote agriculture, commerce and industry in North Dakota.
Although the BND is operated in the public interest, it avoids rivalry with private banks by partnering with them. Most lending is originated by a local bank. The BND then comes in to participate in the loan, share risk, buy down the interest rate and buy up loans, thereby freeing up banks to lend more. One of the BND's functions is to provide a secondary market for real estate loans, which it buys from local banks. Its residential loan portfolio is now $500 billion to $600 billion. This function has helped the state avoid the credit crisis that afflicted Wall Street when the secondary market for loans collapsed in late 2007 and helped it reduce its foreclosure rate. The secondary market provided by the "shadow lenders" is provided in North Dakota by the BND, something other state banks could do for their community banks as well.
Other services the Bank provides include guarantees for entrepreneurial startups and student loans, the purchase of municipal bonds from public institutions, and a well-funded disaster loan program. When North Dakota failed to meet its state budget a few years ago, the BND met the shortfall. The BND has an account with the Federal Reserve Bank, but its deposits are not insured by the FDIC. Rather, they are guaranteed by the State of North Dakota itself - a prudent move today, when the FDIC is verging on bankruptcy.
A state-owned bank has enormous advantages over smaller private institutions: states own huge amounts of capital (cash, investments, buildings, land, parks and other infrastructure), and they can think farther ahead than their quarterly profit statements, allowing them to take long-term risks. Their asset bases are not marred by oversized salaries and bonuses, they have no shareholders expecting a sizable cut, and they have not marred their books with bad derivatives bets, unmarketable collateralized debt obligations and mark-to-market accounting problems.
The BND is set up as a dba: "the State of North Dakota doing business as the Bank of North Dakota." Technically, that makes the capital of the state the capital of the bank. The BND's return on equity is about 25 percent. It pays a hefty dividend to the state, projected at over $60 million in 2009. In the last decade, the BND has turned back a third of a billion dollars to the state's general fund, offsetting taxes.
By law, the state and all its agencies must deposit their funds in the bank, which pays a competitive interest rate to the state treasurer. The bank also accepts funds from other depositors. These copious deposits can then be used to plow money back into the state in the form of loans.
Although the BND operates mainly as a "bankers' bank," other publicly-owned banks, including the Commonwealth Bank of Australia, have successfully engaged in direct commercial lending as well. This has proven to be a win-win for both the borrowers and the government. The public bank model also offers exciting possibilities for refinancing the state's own debts and funding infrastructure nearly interest-free. For a fuller discussion, see "Cut Wall Street Out! How States Can Finance Their Own Recovery."
For three centuries, the United States has thrived on what Benjamin Franklin called "ready money" and today we call "ready credit." We can have that abundance again, by generating our own credit through our own state and local banks. Just as George Bailey needed a visit from an angel to point the way, so we just need the vision to see the possibilities.
Arianna's vision for moving our money from the large banks into our local community banks is a very admirable first step. However, those community banks are not likely to have sufficient capital to free up credit for their local businesses and other customers without the partnership of state-owned banks, or the publicly-owned banks of counties and larger cities, which also have ample capital assets. A number of states, counties, and cities are actively exploring this option. The BND model shows us how government-owned banks and community banks can work together to get money flowing back to Main Street again.
Follow Ellen Brown on Twitter: www.twitter.com/ellenhbrown
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Furthermore, having any generated revenue go into the states' coffers to offset taxes or to provide funding for essential social services, like health care, etc., would be an ideal outcome.
But isn't it less about putting one's money into community banks or state created banks, and more about using credit cards created by such financial institutions? I suppose you can't effectively have one without the other.
Thank you, Ms. Brown, for putting forth this idea and article, and encouraging the dialogue necessary to create that "change we can believe in".
Since we own Freddie and Fannie and the govt is now connected to 90% of mortgages, why not write the American Dream into law and cut everyone's mortgage in half?
How? By absorbing the private Fed into the public Treasury (public money creation, as the constitution stipulates) and giving Americans what banks now get - direct access to the discount window for primary mortgage finance to credit worthy Americans. Use interest free money for all public debts as well.
Most debt is in mortgages so this would have a huge impact. The Wall Street bankers blew it so should be cut out.
Talk about economy stimulation. This would solve many problems permanently.
Cut the bankers out of the middle.
If I may elaborate, before anything good can happen, we must change the money game in Washington. I suggest we first:
- Ban political TV advertisements.
90% of campaign contributions go to TV. These adds mislead us anyway and are bad for our democracy. Like we did with cigarette advertisements. Long term we must change how campaigns are financed.
If I were Obama, I would ditch the flawed and unsustainable neo-liberal approach and hire you, Michael Hudson, and if possible Steve Keen from Austrailia as my economic team. Now that would be change you can believe in!
I want to share this next thing with everyone. When I was a kid, the coolest building in North Hollywood was The Commonwealth Home Loan Building on Lankershim. It was designed by a student of Frank L. Wright. It had a glass elevator that went up 6 floors to a café at the top. We could see in all directions from the café. If you go to this site, there is a picture of it.
http://www.laconservancy.org/issues/issues_commonwealth.php4
---Kent Ecklund (musician)
Go check them out, talk to them and if you like them, go for it and open an account.
I totally get the bank profits being used to subsidize/replace tax revenue, but expansion and contraction of credit beyond what was occurring 2006 just seems plain unsustainable bubbly to me. If you suddenly provide as much, if not more credit than available then, don't you further oversupply things until your reach an even higher supply of say, houses, beyond what can be filled with actual people, at least in US that seems possible at some point. People were buying multiple houses, investment houses, lake homes. Considering how much labor goes into building infrastructure to service house lot, building materials, construction labor etc...is right to assume but for credit, all regular person working 40 per week is generating enough economic production to justify owning several houses.
I'm confused.
Excellent idea...quite the opposite of loan mods to 40 year or interest only!
I'm a big supporter but I still wonder how much of our problem is due to over-capacity, boom/bust and how this fits into credit supply. I'm sure I'm limited in vision as we are not presented much in the way of alternatives to our current monetary system, so I'm curious about your take on this.
Is not possible to build more capacity than society needs and the have a resulting overhang. They really did build too many condos, in that I mean more condos then people that were interested in condos. So when they were overbuilding some residential stuff, they also overbuilt the manufacturing sectors to supply that boom.
So now, even if people have cash, they are not likely wanting to spend it on a manufacturing plant, building a spec home etc. Fan and Fred are making credit available to those who can afford to service loan, again at very low rates, at least for low end of market, and still these peoples income are being maxed out on housing costs in a way a generation ago was never. But they are selling homes for less than the cost of buying lot at today's reduced prices and building from scratch due to seeming oversupply. Is this just due to credit tightening or true oversupply/bubble. And wouldn't more affordability of housing (housing costs in relation to wages have been killing middle class for some time) be a good thing overall.
Michigan really needs new re-investment now. Michigan really needs a state bank.
I so wanted O to at least create a National Bank right from the beginning of this mess. If he didn't have the stones or the advice/knowledge to do what Roosevelt did, then the least he could have done was give us a bank that we could believe in. I wrote to him many times and posted with many others here that we needed this.
I have taken all my money out of the big banks, some time ago, actually. This isn't easy for many people in this vast country, if we really want to do something for ourselves we will get this movement going on out own and maybe we can shame O into giving us a bank.
Dear Mr. President,
Give the people a national bank to help rebuild the system from the ground up. We are going to take our money out of your friends' banks and make them g back to treating us fairly or go out of business. You missed this opportunity the first time- strike one. You, Bernanke and Bush gave away our money to save the criminals- strike two. One chance left.
Just about every Main Street of my youth has rotted away and disappeared. A section of land that had 1.5 families then, is lucky if it has a family at all now. The land is empty. Where did all the people go? A whole bunch of them followed Lawrence Welk to California. My high school class - 90% of them have moved out of state to find a job and a life.
These are farming states. They have very little opportunity. They export their kids to big states so they can find work.
You won't find any answers in North Dakota. If they had not been able to export to kids to states that had growing economies, their kids would have been largely unemployable for life.
There are very few differences between the economies of South Dakota and North Dakota. North Dakota has a state bank. South Dakota does not.
When coupled with the land redistribution that took place during our first Great Depression and continues in this one, there has been a massive and little noticed diaspora of farm families, forced off the land they've held for generation through the monopoly practices of the food production system working hand in glove with the banks.
Most people don't realize that in our current monetary system, private banks, including the Federal Reserve, create out of thin air -- whenever anyone, including the government, takes out a loan. On the money the private banks create out of thin air, the private bankers collect interest, accumulating huge wealth for doing nothing to earn it. With this wealth, the private bankers have acquired huge power and control the media, Congress, influence the president, and influence US and world events, all for their own private benefit.
The authority to create money belongs to the people. The US Constitution places this authority in Congress. Money is the medium of exchange by which we exchange goods and services -- further, it is an abstract social invention that serves the purpose of advancing commerce and trade beyond the barter process. (Money should not be confused with wealth, where wealth is a comination of resources and labor.) The creation of money should be the sole prerogative of a sovereign government. The free market then exists within this environment of money created by the government (via public banks, for example), as money is just a means to facilitate transactions.
Very well done, Ellen.
You and Arianna are making a very good team.
To the degree that a shortage of lending capital is the problem at most small banks, her success in moving both savings and checking accounts to community banks will surely provide some of the Main Street bank money.
This history of the breakdown of soundness regulation has seldom been laid out so clearly.
And the people are thinking about money.
And of having a people's banker.
Very well done.
Community banking.
Cooperative banking.
Credit Unions.
We have earned the full faith and credit in ourselves.
My hope is that these same people see that the banker's banker at the Fed has failed miserably in contributing to the cause of the breakdown of those money-soundness barriers.
And raise the question of why there should be private banker's banker, one that provides the bankers with a hand in the taxpayer's pocket.
Community banking on a national scale.
The Money System Common.
End the private Fed.
This makes a lot of sense, strengthens local communities, restores Main street's ability to create a thriving economy reflecting the needs of the people in that area. BND has clearly done that for North Dakotans who have high employment while the rest of the country has high UNemployment.
So...why hasn't this been done? Simple:
1. The banksters and pimp politicians are not yet motivated to serve the public good rather than the banks' profits.
2. The corporate media will not lay-out the obvious facts as Ellen does here. This idea has a long history in different forms. In fact, 86% of teaching economics professors preferred taking power from the big banks during the Great Depression for arguments as sound as what you've read here.
3. From personal experience discussing state-owned bank policy with California legislators and leading economists, these ideas are too far from the familiar for them to easily add 2 and 2 together.
This is where you, the reader, come in. Your continued activism will bring this idea into the familiar. Thank you in advance for your actions to build a brighter future in this and all other areas of your commitment.