How California Can Create Its Own Credit:

OWN A BANK!

Ellen Hodgson Brown, J.D.Public Banking Institute

March 2011

THE GOLDEN STATE GOES BROKE

Once the world’s 8th largest economy – visionary, progressive – leading producer in agriculture, industry, technology, entertainment . . .

California is now teetering on bankruptcy, with a deficit for 2011 of $26.6 billion. More than 1/4th of the deficit -- $7.65 billion – is just for INTEREST.

The choices being debated are all unacceptable.

Everything is up for sale. That could work this year, but what do we do next year?

Tuition hikes are making “public” universities unaffordable.

• UC BERKELEY: Tuition is now $12K/year.

• UCLA Law School: tuition is now $40K/year.

• Total tab at Berkeley: $34K/yr x 4 = $136K + grad school = $200K.

• $200K @ 7% for 30 years = $1330/mo. – the equivalent of a mortgage!

• And it’s not dischargeable in bankruptcy.

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In the 1960s, tuition at Berkeley was FREE. And in the 1970s, tuition at UCLA Law School was 500/year. Or so I remembered it . . . Prof. Gray Brechin, UC Berkeley Dept of Geography, confirms. His commencement speech, 2009:

“When I tell students that when I came to Berkeley in 1967, there was virtually no tuition, you can hear their jaws hit the floor. I took it for granted then; no one told me that I was the unwitting beneficiary of New Deal idealism . . . “

He described what was done in the last Great Depression, something we can do again today . . .

“[An] alternative universe is all around us, the enormous legacy of public works created by New Deal agencies in only a few brief years. . . By putting millions of Americans to work doing everything from laying sewers and running WPA health clinics to painting murals and planting forests, these public works began to lift the economy out of the last Great Depression.”

“In 1960, aging New Dealers like Governor Pat Brown . . . put in place California’s Master Plan for Higher Education that promised free tuition regardless of income.”

Governor-elect Jerry Brown grew up with this vision. We can inspire him with it again.

• We’ve still got the manpower, the resources, the expertise, the imagination.

• All we’re lacking is the MONEY. Where will we get it?

• In the same place the Fed got the money to bail out Wall Street . . .

WHERE’S OUR BAILOUT?

While state economies are floundering, Wall Street is flourishing.

••

Somehow, the government and the Fed managed to turn $800 billion into $12.3 trillion ($3.3 trillion in liquidity and $9 trillion in short-term loans).

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But while the banks that perpetrated the crisis are being lavished with bailout money, it isn’t making it to Main Street.

The Fed says state and local governments are on their own.

Wall Street Journal, January 8, 2011:"We have no expectation or intention to get involved in state and local finance," Mr. Bernanke said in testimony before the Senate Budget Committee. The states, he said later, "should not expect loans from the Fed.“

Not that the Fed can’t afford it. Compare the states’ total budget shortfall . . .

. . . to the bank bailout.

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State and local governments are like colonies, in a two-tiered system in which the TBTF banks get all the perks – perks the states could get as well, if they had their own banks.

BANKS --• Can borrow overnight at

0.2% (the Fed funds rate) and at 1.27% on 6-mo. CDs.

• Lehman Bros. and Bear Stearns were rated AAA a month before bankruptcy.

• The Fed dropped interest rates to near zero to save the banks.

• Banks have unlimited low interest credit lines with the Fed and federal government.

STATES --• States rated AA pay an

average of 4.45% on 20 year bonds.

• A year ago, CA was rated BBB (just above Greece).

• Near-zero interest caused massive losses to local governments on interest rate swaps – on which Wall Street made a killing.

• NO credit line with the Fed.

Municipal governments are in even worse shape.

• Lacking low-cost unlimited credit lines, munis must maintain costly rainy day funds (reported in CAFRs), or issue bonds at “market” rates.

• Muni woes began in 2008, when their INSURERS lost their credit ratings from gambling in derivatives, driving up muni bond rates.

• Credit default swap spreads are greater for some local governments than for Greece and Spain.

• The market is now fleeing munis, fearing bankruptcies --a self-fulfilling prophecy. If the market abandons the munis, where will they get much-needed credit?

Let’s see . . . Where did the FED get the money for the bailout?

Congress too wanted to know . . .

House Speaker Nancy Pelosi,June 2009:"Many of us were, shall we say, if not surprised, taken aback when the Fed had $80 billion to invest -- to put into AIG just out of the blue. All of a sudden we wake up one morning and AIG has received $80 billion from the Fed. So of course we're saying, Where's this money come from? 'Oh, we have it. And not only that, we have more.’”

The secret was revealed by Art Rolnick, former Chief Economist, Minneapolis Fed:

“We make money the old-fashioned way: we print it.”

But what about the states? In 2009, Governor Schwarzenegger declared --

“I understand that these cuts are very painful and they affect real lives. This is the harsh reality and the reality that we face. Sacramento is not Washington – we cannot print our own money. We can only spend what we have.”

That’s true, UNLESS we own a bank . . .

HOW BANKS CREATE MONEY –AND CALIFORNIA COULD TOO,

IF IT OWNED A BANK

Banks can do two things that no other entity can --

• Have access to “liquidity” – loans from other banks at very low interest.

• “Leverage” their capital, actually turning it into additional money in the form of loans.

• Note that we’re not just talking about relending existing funds. States already do that with “revolving funds.” We’re talking about creating NEW MONEY, money that did not exist before.

As Treasury Secretary Robert B. Anderson put it in 1959:

“[W]hen a bank makes a loan, it simply adds to the borrower’s deposit account in the bank by the amount of the loan. The money is not taken from anyone else’s deposit; it was not previously paid in to the bank by anyone. It’s new money, created by the bank for the use of the borrower.”

Most of the money supply was created in this way as “bank credit.”

Private debts zero out when repaid, but the federal debt is never paid off. That means the federal debt basically IS our money supply. When private debt shrinks, government debt MUST increase to maintain a stable money supply. No debt means no money.

The loan money is created by double-entry bookkeeping.

$500,000 Home Loan

Liabilities Assets

Customer Account

$500,000

Customer’s Home Mortgage –

$500,000

Net result: 0.

The money is multiplied through the magic of fractional reserve lending. The Dallas Federal Reserve explains:

“Banks actually create money when they lend it. Here's how it works: Most of a bank's loans are made to its own customers and are deposited in their checking accounts. Because the loan becomes a new deposit, just like a paycheck does, the bank once again holds a small percentage of that new amount in reserve and again lends the remainder to someone else, repeating the money-creation process many times.”

• http://www.dallasfed.org/educate/everyday/ev9.html

Deposits become loans . . . become checks . . . become deposits in other banks.

Modern Money Mechanics, p. 49:“With a uniform 10 percent reserve requirement, a $1 increase in reserves would support $10 of additional transaction accounts.”

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Cumulative expansion in deposits on basis of 10,000 of new reserves and reserve requirement of 10%.

Expansion stages Final

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That’s the conventional model, but banks actually create the loans FIRST. They find the deposits to meet the reserve requirement later.• Banks can originate all the

loans they can find creditworthy borrowers for, but they need incoming deposits (“LIQUIDITY”) to clear the checks.

• If they don’t have the deposits, however, they can borrow them.

How banks create “liquidity” --

A creates $1000

C creates $1000

B creates $1000

• Banks create money as loans, which become checks, which go into other banks.

• Then, if needed to clear the checks, they borrow back the money they just created.

• Here’s the beauty of it –they borrow at the Fed funds rate, and it’s now 0.2% interest for overnight loans.

The rate was dropped to bail out the banks, but this windfall isn’t passed on to us. States are borrowing at 4-5% and consumers at higher yet. The banks keep the spread.

Meanwhile, local credit is shrinking because of “deleveraging.” The money multiplier effect is working in reverse.

Why? There are other limits on credit creation besides the cost of funds --

• The capital requirement: $8 of capital is required per $100 of loans. The loss of $8 in capital removes $100 in credit potential.

• Creditworthy borrowers: Now that the subprime boondoggle has been exposed, banks can no longer dump “toxic” mortgages on investors. They are therefore becoming much more selective about borrowers and terms.

The capital requirement

• The capital requirement was imposed by the BIS in Switzerland for international lenders (Basel I, Basel II and Basel III)

• “Capital” means the bank’s own equity, not the money of depositors.

• This is what chiefly limits local bank lending today.

Banks thus need 2 things to create money as credit: capital (equity) and deposits (“liquidity”).• State and local governments have HUGE amounts of

capital (including real estate and various funds) and HUGE sums in bank deposits (including taxes and payroll).

• By investing their capital on Wall Street and depositing their revenues there, they are giving this enormous credit power away.

• Wall Street banks are not interested in local projects –low-cost housing projects, renewable energy, etc.

• They are more interested in international finance and foreign investment –leveraging OUR state money to invest in China and other competitors.

• Local banks WANT to invest in local projects.

• But they can’t, because they lack the capital and deposit base for these large loans.

HOW CALIFORNIA COULD TAP INTO WALL STREET’S PERKS: OWN A BANK

• If the state had its own bank, it could leverage its own capital and deposits into credit for local government, local banks and businesses.

• The state bank could have access to Fed funds at 0.2%.

• The state bank could partner with local banks to help with capital requirements.

• The state bank could buy muni bonds, saving the cities from insolvency while generating a nice return for the state.

A GROWING GRASSROOTS MOVEMENT

• A number of state legislatures have introduced bills for state-owned banks, including OR, MD, WA, HI, IL, MA, and VA.

• In the last election, a number of candidates also proposed this solution, from all across the political spectrum -- Democrats, Republicans, Greens, and Independents.

• Careful analyses of the Washington and Oregon bills done by the Center for State Innovation showed substantial employment and revenue gains for both. See http://StateInnovation.org.

These states are all following the lead of North Dakota, the only state to have its own bank – and the only state to have a major budget surplus.

North Dakota has had its own bank since 1919, when farmers were losing their farms to the Wall Street bankers. They organized, won an election, and passed legislation.

ONLY NORTH DAKOTA ESCAPED THE CREDIT CRISIS.• In 2009, while other states floundered, North Dakota had its

largest budget surplus ever.• The Bank of North Dakota (BND) has an average return on

investment of 25-26%.• ND has the lowest unemployment rate in the country, the

lowest default rate, and the most local banks per capita.

The BND has a captive deposit and capital base. All state revenues are deposited in it by law. (Only 1% of its deposits are from consumers.) Further, the BND is a dba of the state. That means that ALL the state’s assets are the bank’s assets.

Consider the possibilities for California . . .

• CA has funds in a Pooled Money Investment Fund managed by the Treasurer totaling $71.4 billion as of January 31, 2011, earning a very modest 0.65%interest in 2009-10.

• CA has a Public Employees Retirement Fund holding $201.6 billion at the end of 2010.

• In 2008, CalPERS LOST 25% in Wall Street investments, and in 2009 it LOST 31%.

• Compare the BND (rated A+ by Standard & Poor’s), which had a return on investment in 2008 of 26% and has delivered over $300 million to the state treasury in the last decade – impressive for a population only 1/14th

the size of L.A. County.

If the $201 billion in the CalPERS pension fund were invested in a state-owned Bank of California, the bank could have a market cap greater than any private bank in the world.

Data as of June 2010.

But we don’t need to go that far . . .

• At an 8% capital requirement, investing only $12 billion of this money as equity in the state’s own bank could back a potential loan portfolio of $150 billion.

• The state has a variety of funds, some of which are sitting idle and could be tapped into without ruffling political feathers.

• Note that bank capital isn’t “lent.” It is an investment in equity, which grows like other investments.

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What about the deposits to back this $150B? Extrapolating from he the BND model, using ONLY state government revenues --North Dakota: • Population 647,000• Deposits $2.7B• Deposits per capita –

approx. $4000• Loans $2.6BCalifornia:• Population 37,000,000• At $4000/person,

deposits = $148 B• Potential loans = $142 B

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What could CA do with $142 billion?

• Fund infrastructure and other public projects interest-free. Cutting out interest reduces the cost of projects 30-50%.

• Rehire 20,000 laid-off teachers = $3.4B/yr.

• Partner with local banks, guaranteeing and sharing in low-interest loans to local businesses and homeowners.

• Reduce state tuition or give interest-free student loans.

And more . . .

• CA could buy $142 billion in muni bonds, generating interest at 5% of $7.1 billion -- enough to service nearly the whole state debt ($7.65 billion).

• While we’re thinking creatively, here’s another idea: Most states are required to balance their budgets, but NOT CALIFORNIA. Like the federal government, it has to pay the interest on its debt but is allowed to roll over the principal.

• Like the federal government, it could continue to carry the debt and just service it. If funded through its own state bank, interest would effectively be free.

California General Obligation and Revenue Bonds as of Nov 1, 2010

http://www.treasurer.ca.gov/bonds/debt/201011/summary.pdf

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• Interest is nearly half the obligation on CA’s general obligation bonds (mostly for infrastructure).

• Studies show that eliminating interest could cut the cost of public projects by 30-50%.

Consider a typical project –the controversial Maine Turnpike

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• $100 million in annual toll collections

• Over 1/3 is interest --largely going to Wall Street.

• The state could cut the project cost by 1/3 by returning the interest to its own state bank.

Investments in education and infrastructure can pay for themselves.

• Example: the G.I. Bill, which paid for itself many times over with increased productivity and taxes.

• Cutting out interest cuts project costs in half and makes otherwise non-sustainable projects sustainable.

Protection from the “bond vigilantes”

• In 2003, CA was called the world’s 6th largest economy.

• It could and probably should have its own “central” bank, if only to maintain its independence from bond speculators. Why should an economy the size of California’s be a vassal of Wall Street, subject to the whims of speculators, when it has the resources to generate its own credit?

Now apply the money multiplier to the $142B . . .

• As the state bank’s $142B in loans become checks, they go into other banks, multiplying the deposits and the credit potential of the whole banking system.

Where would the local banks get the capital to back all these new loans? In North Dakota, the BND helps with capital requirements. It does this through:

• Loan purchases• Participation loans

Letters of credit (loan guaranties)

• Note that the BND does not compete with other banks; it partners with them.

• The North Dakota Bankers Assn strongly endorses the BND.

With a state “bankers’ bank” to back them, local banks can turn muni government revenues into lendable funds, further expanding credit.

• In ND, municipal government deposits go into the local banks -- NOT into the BND.

• But government deposits have to be “secure,” which means either FDIC-insured or backed by “collateral.”

• Since the FDIC insures only up to $250K, the bulk of the larger deposits must be invested in collateral such as Treasuries and are not available to back loans.

• With a BND letter of credit, this money IS available for loans.

Advantages of a state-owned bank: summary

• State revenues remain in the state, generating local credit.

• Profits return to the state government, defraying taxes.• Low-cost credit line replaces costly “rainy day” funds.• Infrastructure projects can be funded interest-free with the

state’s own credit. • No high-paid CEOs; no bonuses, commissions or fees; no

toxic collateral; no fears of lost credit ratings.• Honest lender with a mandate to serve the community

replaces “city slicker” bankers selling derivative scams to unwary local politicians.

• No shareholders demanding short-term profits: the bank can take the long view in serving the public interest.

The Bank of California, like the Bank of North Dakota:

• Would PARTNER, not COMPETE, with local banks.• Would involve INVESTING, not SPENDING, the state’s capital.• Would MAKE rather than COST money long-term. • Would involve LESS RISK, not MORE, than the Wall Street

alternative.• Would ADD jobs, ADD revenues, INCREASE local credit, and

SUPPORT the local banking system.• Would introduce TRANSPARENCY and ACCOUNTABILITY

into banking, and a MANDATE TO SERVE THE PUBLIC INTEREST.

• Would mean ECONOMIC SOVEREIGNTY.

As Buckminster Fuller said --

“You never change things by fighting the existing reality. To change something, create a new model that makes the old model obsolete.”

For more information –http://PublicBankingInstitute.org

http://WebofDebt.com