The ABCs of public banking
Posted: Tuesday, June 3, 2014 6:00 am
By Mike Krauss
The Bucks County Courier Times
Public banks are capitalized with public funds and can hold state and municipal deposits safely away from the gamblers on Wall Street.
As with any bank, these funds are leveraged, but work in partnership with the local banking industry to meet the needs of communities they serve for affordable credit — to grow local economies, create jobs and tax revenue, reduce debt and help insure sound public finances. Banking in the public interest.
This is the model developed with huge success by the Bank of North Dakota (BND). Across the nation, almost two dozen states and as many counties and municipalities are considering how best to establish similar public banks. Each faces similar challenges.
The first is to define mission. Generally, it’s all about generating affordable and sustainable credit to support locally directed economic development. But, where to direct that credit and the bank’s profits, which belong to the only shareholder, the people?
This depends on the needs of the people of the chartering government entity and varies from place to place, but here is a sample of what some communities are considering:
Provide mortgages and financing to reclaim the vacant buildings and properties that blight many neighborhoods, for homes or businesses. Support small businesses job creation. Refinance underwater mortgages. Consolidate student loans at lower interest. Reduce public debt. Finance community health centers. Support existing development agencies and infrastructure investment. Direct profits to schools and public safety.
The second challenge is capitalization. The Bank of North Dakota was started with a bond issue. Because the bank pays off its own bonds (self liquidating) that is an option. But this will depress profits in the early years of operation.
The option gaining the most traction is to examine existing public investments, identify those that are under-performing and replace them with an equity position in the bank. Prudent portfolio management.
The public Bank of North Dakota (BND) has consistently returned 17 to 25 percent on equity. I know of no municipal, state or pension fund investment that comes close. And some municipal investments are just dumb.
For example, Philadelphia and Pennsylvania both report in their Consolidated Annual Financial Reports (CAFR) major investments in foreign instruments — a staggering $1 billion in Philly. Not only is that money not invested in the city or state, it’s not even invested in America.
Moreover, few of these investments, whatever the return, can demonstrate any reinvestment in or tangible benefit for the communities whose money it is.
The third issue is governance. It is vital that, as in North Dakota, bankers run the bank and not politicians. Most adult Pennsylvanians will know what I am talking about.
Certainly, elected officials responsible for public funds must be able to remove a public bank CEO for cause. But staffing and management must be left to a CEO and directors with demonstrable banking experience, insulated from political manipulation and patronage hiring.
The forth issue is accountability. Elected officials must be able to insure the defined mission of the bank is fulfilled, which they may modify from time to time, and that the bank meets performance targets, or the CEO goes.
Fifth is transparency, which is vital for accountability. But a public bank is both subject to regulation and audit by state banking examiners, and is publicly audited by an elected (in Pennsylvania) controller, also accountable to the people.
Then there is risk management, which is enhanced by public banks. Because loans are originated by a commercial lender which must first approve the risk, and only then offered to the public bank for participation, which must conduct its own, independent risk assessment, the risk of default is substantially reduced. The highly profitable BND has one of the lowest default ratios in the nation.
There are other policy and management issues which must be addressed in any business plan and would be familiar to any banker, such as policies for capital, deposits, lending, profit analysis, interest rate risk and managing the bank’s investments.
In proposing public banks, the Public Banking Institute and Pennsylvania Project approach state lawmakers, city council members, mayors, county commissioners and those who have charge of public funds as if they were being asked to invest in a start-up, which in effect they are, and these officials must proceed with due diligence.
But this is not rocket science. It is the sound banking with which our community bankers are familiar, but was abandoned by Wall Street.
Advocates for Pennsylvania public banks are not proposing to re-invent the wheel — just to roll it down to our commonwealth from North Dakota.
Ellen Brown, who is an attorney, has written an article about what she calls “An Economic Bill of Rights”. I will argue that her case is totally wrong. It is totally permeated with factual and conceptual errors.
Even without my showing precisely how her financial analysis is in error, we can understand that she is propounding nonsense by looking at her pie-in-the-sky conclusion:
“If the government owned the banks, it could keep the interest and get these projects at half price. That means governments – state and federal – could double the number of projects they could afford, without costing the taxpayers a single penny more than we are paying now.
“This opens up exciting possibilities. Federal and state governments could fund all sorts of things we think we can’t afford now, simply by owning their own banks.”
Brown wants government to double in size. That would make it 80 percent of the economy. This is nonsense. It is an impossibility. If government becomes 80 percent of the economy, the economy will shrink drastically because productivity will plummet. Not only that, huge amounts of capital will flee the country.
Brown thinks that this expansion can be done costlessly. That is, she thinks that the resources absorbed by government are costless. This is patently false. All resources diverted to government are taken away from persons who would otherwise use them for their own purposes. The diversion removes the opportunities for private use. Hence the cost of the diversion to government is, at a minimum, the opportunity cost of those resources or capital. And that’s a minimum cost because it excludes the costs the government incurs in seizing the resources and the costs incurred in misallocating those resources after they are seized.
Brown doesn’t understand the effects of government on private economic behavior. She doesn’t understand government’s inefficiency and incapacity to be productive. She doesn’t understand cost, that is, opportunity cost.
Brown thinks that there is a governmental free lunch. She thinks she has discovered a free lunch that has up to now eluded realization and perhaps discovery by the human race. She seems not to realize that the Russian and Chinese Communists did what she is proposing. They absorbed all the banks. They mobilized all the capital they could lay their hands on. They funded all sorts of things. The costs of seizing this capital were enormous. Millions of people were killed, imprisoned, and sent to gulags. Millions were impoverished. Misery mushroomed. The results were total failure.
The difficulty in rebutting what she says is that her message has been reduced to a simple catchy theme. It is a false theme, but it still has the power to attract. Her theme appeals to anti-banker sentiments. It appeals to anti-interest sentiments. She asserts that the prices we pay for goods are 40 percent interest costs. This catches one’s attention, but it is total nonsense. It is totally wrong. It is outrageously high and exaggerated.
She goes on to assert that this cost, whatever size it is, magically disappears if government owns the banks. This is also entirely wrong. If a government company builds a car, the capital it obtains in order to begin production has, all else equal, the same cost as if Toyota were to obtain that capital. Capital costs do not disappear because production is socialized in the realm of government ownership. Capital still remains scarce.
Furthermore, Brown exaggerates the amount of capital supplied by banks. Somewhere around 60 percent of debt capital is supplied to businesses by the direct purchase of debt instruments in capital markets (estimated using the flow of funds accounts). Banks don’t supply much long-term debt to businesses. Since debt is about 1/3 of overall capital and the rest is equity, banks supply about 0.4 x 0.33 = 13.2 percent of all capital to businesses. These are rough figures, but refinements won’t change the overall conclusion. Even if Brown’s nirvana of socializing or nationalizing banks were brought into being, it wouldn’t touch the vast majority of capital that is directly supplied to companies.
I will now argue that her 40 percent figure is vastly overstated. To do that, we will take an excursion through the basic finance of which Brown is apparently ignorant.
What is capital? Capital consists of all goods that people intend to use for activities that are intended to satisfy future wants, as opposed to consumer’s goods that are used to satisfy immediate wants. Capital is measured in terms of a money unit of account.
Businesses that produce goods for future consumption use capital in their processes of production. This capital is scarce, which means it is definitely not free or costless. There is competition to obtain capital. There are markets for it called capital markets. There is supply of capital and there is demand, and their activity produces a cost of capital that is positive or above zero. If the price or cost of capital were zero, the demand for it would vastly exceed the supply.
All capital has a cost, which is in fact called the “cost of capital”. This cost doesn’t vanish if a business owner supplies his own capital to his own business. A person who uses his own capital in his business loses the opportunity of supplying it to others at the market price. He loses income that he could have gotten by allowing others to use his capital. This person has an opportunity cost of capital. If he makes a rational calculation and accounting, he should demand of his business that it pay back to him this implicit cost of capital that he has diverted away from an external market and used instead for his own business purposes. What he has given up by not placing his capital in an external market he should at least recover by using it for his own purposes. He should, in essence, pay himself for the use of his own capital.
The cost of capital doesn’t vanish if a government takes capital from its citizens and uses it for government activities or government-owned businesses. If we think of the government as a kind of organization owned by citizens, then, in the employment of capital by the government, the citizens are analogous to a business owner that employs his own capital in his business. That is, there is still a cost of capital used by the government when citizens supply their capital or are forced to supply it to the government. They lose the opportunity of deploying this capital elsewhere in productive enterprises, and that loss measures the cost to them of government’s absorption of the capital.
In other words, no magical gain occurs when government absorbs and deploys the capital that it extracts from citizens. The basic reason that no gain occurs is that capital is scarce, which means it has a cost. That cost doesn’t vanish as capital is shifted from one owner to another, including government ownership.
Brown fails to recognize this basic fact. She wrongly thinks that if government keeps the interest that it gets its projects at half price. All that happens, however, is that government recovers the cost of capital for itself. The projects don’t cost any less at all. Her error is like thinking that a man who uses his own $3,000 to build a motorcycle can build it at half the cost of someone who borrows the $3,000 from a bank to build it. Obviously the costs of the materials, labor, and so on are the same. The cost of the capital is less obviously present. With bank borrowing, the man pays interest. Let us suppose that it’s at 6 percent for one year, so he pays $180. The man who uses his own $3,000 loses the opportunity to invest his funds externally. If he can invest at 6 percent, he loses $180. This is a real cost to him of using his own funds. There is a finance cost regardless of whether the bank funds the project or the man funds the project himself.
All users or demanders of capital bear the cost of capital. They pay it to capital suppliers to induce them to save, that is, to forego consuming their resources and instead to invest them. The cost of capital also includes payment for the risks that savers bear when they transfer their capital to the users of capital.
Next, I expose the absurdity of her 40 percent number.
How large are capital costs? A significant company might have 1/3 debt and 2/3 equity capital. The cost of debt might be 6 percent. The cost of equity might be 9 percent. The weighted average cost, excluding tax effects, is then 8 percent (1/3 x 6 + 2/3 x 9). These numbers are made up, but they give a reasonable idea of overall capital cost. I will use that 8 percent figure below.
A company employs capital and it has a balance sheet. On one side, the left hand side, are the assets employed in the business. The left side provides measures in money terms of the assets that the business managers have decided to employ in the business in their production processes, such as buildings, a cash account, inventories, vehicles, computers, etc. The left side assets are capital in forms thought to be productive. On the other side of the balance sheet, the right hand side, are the liabilities (debts) and equity (or ownership) capital that finance the business. It shows capital in the form that capital-suppliers have agreed to make available to the business. The balance sheet always balances. The money valuation of the left side assets equals the money valuation of the right side liabilities and equity capital. We may use either total to measure the total capital deployed in the business.
We see that the total capital employed in the business is measured in book value (accounting) terms by either all the assets on the one side or all the capital (debts + equity) on the other.
Let’s do a hypothetical example in which we use the cost of capital as 8 percent. Suppose the company has $100 of assets. Then it has $100 of capital in the business. These assets have to earn $8 in order to cover capital costs of one year. Suppose that the business has sales revenues of $150 during the year. The revenue is not business profit. Much of this revenue will be absorbed by operating costs, such as payments for labor services, payments for energy, payments for goods purchased from other companies, payments for transportation, payments for advertising, payments for distributions, etc. One of the costs is the cost of capital. On income statements that calculate business profits, the costs of debt are explicitly accounted for by interest costs. The costs of equity capital are not explicitly accounted for, but they are still real. It is a mistake to overlook them.
Business managers attempt to lower their costs so as to produce greater profits. They will attempt to obtain capital to finance the business at the lowest cost they can, all else equal. They might conceivably measure their capital cost as a fraction of their sales revenues. This ratio is not one that is ordinarily calculated in doing a financial analysis. This is the ratio that Ellen Brown cites and relies upon as being about 40 to 50 percent.
In our example, the ratio is $8/$150 = 5.33 percent. The estimate of 40-50 percent intuitively seems way too high, and it is way too high. It means that on a complete income statement of this company the capital costs are $60 to $75. Suppose we use the 40 percent number or $60 of capital costs. Suppose that debt costs are 6 percent. With debt as 1/3 of capital, that means that debt costs are 0.06 x $33.33 = $2. That leaves $58 for the equity costs. The equity costs are $58/$66.67 = 87 percent. This is outlandishly high. It is caused by Brown’s outlandishly high estimate of 40 percent capital costs. Actual equity costs in the real world are nowhere near 87 percent. They range from 8 to 15 percent for many established corporations. They run higher than that for more risky enterprises, perhaps 15 to 25 percent. They don’t run 87 percent for businesses with reasonable prospects.
What would be more reasonable? In my example, if $8 are capital costs and if $2 of this is for debt, then the remaining $6 is for equity. The equity cost is then $6/$66.67 = 9 percent. That is more reasonable. Very long run returns on common stock equity are near this number. Long run returns on the accounting value of equity may run somewhat higher, more like 10-12 percent. That still comes nowhere close to a number that justifies the assertion that capital costs are 40-50 percent of the selling price of goods, and that is what Ellen Brown asserts:
“According to Margrit Kennedy, a German researcher who has studied this issue extensively, interest now composes 40% of the cost of everything we buy. We don’t see it on the sales slips, but interest is exacted at every stage of production. Suppliers need to take out loans to pay for labor and materials, before they have a product to sell.”
Brown’s bottom line proposal is that the government create money instead of the banking system. She wants the government to set up its own banks. She says that this would bypass “the interest tab”. We have seen that this doesn’t bypass the cost of capital at all, not when that capital comprises real resources and the government absorbs these resources. But Brown has another fallacy in mind which is that fiat currency will eliminate the capital cost. She wants the government banks to issue fiat currency which is non-interest bearing and in this way fund projects at what she thinks is a zero capital cost.
Picture a government printing press for currency. Citizens are required to accept the newly-printed paper in payments for goods. Obama’s lieutenants take the paper currency and spend it for their favorite projects. All this amounts to is a different kind of taxation scheme by which the government absorbs (seizes) resources that are in limited supply. The opportunity costs of these seized resources still do not vanish no matter whether the resources are seized directly, taxed through the IRS, or obtained by spending new pieces of green paper.
Brown is committing the same fallacy as the Communists who attempted in vain to get rid of interest. It is an impossibility. The interest measures the postponement of consumption and arises because of it. If there are to be any production processes, they require capital and non-consumption. There will have to be interest. If interest is forcibly suppressed, capital will flee and people will engage in greater consumption. Capital will be consumed and the economy will go downhill. Government printing presses amount to taxes on capital. They will have the same results.
There is much that is wrong with our monetary system. There are a good many critics of it who are offering sound criticisms and sound recommendations for improving it. Ellen Brown is not among them.
Response to Michael Rozeff, “The Many Fallacies of Ellen Brown”
By Ellen Brown
Michael Rozeff has just posted a piece on LewRockwell.com called “The Many Fallacies of Ellen Brown,” responding to my article titled “Time for an Economic Bill of Rights”. Here is a short reply.
Mr. Rozeff seems to think that (1) saving the government money is a bad idea, and (2) keeping the status quo, in which private bankers get the inflated cost of money — a cost that is passed on to the consumer — is a good idea. If he actually believes that, one has to wonder at his competence; and if he doesn’t, one has to wonder at his motives and whom he represents. The post is an appeal to emotion and fear, and mischaracterizes what I said.
The point of my article is that the interest paid by the government could be returned to the government, if the government owned the bank. The government could then spend this money into the economy or reduce taxes by that amount. How this would make government 80% of the economy or turn it communist, as claimed by Mr. Rozeff, is not clear. Forty percent of the German banking sector is publicly-owned. Has this made Germany a communist country? No. The German economy is the most robust and productive in the EU, and it remains capitalist. The public banks service the small and medium-sized privately-owned businesses that are the productive strength of the economy. See my earlier article here. Similarly in Canada: it borrowed from its own central bank effectively interest free until 1974, and accomplished remarkable things with this government-issued capital expenditure, including funding its health care system.
On Margrit Kennedy’s figure of 40% for interest paid on household debt, see her graphs posted here.
The problem with the monetary scheme today is the skyrocketing inequality of wealth, which is mathematically unsustainable; and this gross inequality is caused by the private ownership of credit. “Them that has, gets.” They are the few at the top, the 10% who collect the interest paid by everyone else. A major point made by Margrit Kennedy is that interest is a huge regressive tax, overwhelmingly paid by the bottom 80% who can least afford it, overwhelmingly enjoyed by the uppermost 10%, rigging society with a huge wealth transfer in the wrong direction.
A prevailing economic fallacy is that the total debt borne by the people is unimportant, because it is a zero-sum game: “we owe it to ourselves.” This would be true if “we” and “ourselves” were the same entities, but under the current scheme, they are not. As if everyone in France being in debt to Marie Antoinette would make no difference no matter how high the total debt, even if interest extracted from the average Frenchman for payment to Marie Antoinette climbed so high they could no longer feed themselves, because after all, it is just money owed within France, and one person’s liability is another person’s asset.
The current banking system is unsustainable because the populace does not have enough money left over after paying interest and other costs to purchase the nation’s GDP. Production of GDP therefore drops due to insufficient demand, in a descending spiral called “recession” or “depression.” If the interest is returned to the public, the system becomes sustainable.
“Finance capitalism” is the antithesis of real, industrial capitalism. It is a parasite on industrial capitalism, destroying it from within. As economist Michael Hudson writes:
“To save society, its victims must see that asset-price inflation fueled by debt leveraging makes them poorer, not richer, and that financialization is the destroyer and exploiter of industrial capital as well as of labor.”
Friedrich Hayek, one of the patron saints of Lew Rockwell Libertarianism, wrote in The Road to Serfdom that one price of freedom that needs to be accepted is that it leads inevitably to economic inequality. He cited the then-prevailing salary of a CEO, which was about 30 times the salary of the lowest paid worker. That was in 1944. Today the salary of Bank of America’s CEO is over 400 times larger than that of a beginning teller. Would Hayek think that that disparity was acceptable? Would he think the multiple should be allowed to grow without limit? And even if he would, CAN it keep growing without limit?
When the parasite runs out of its food source, it must and will perish. When that happens, we need to be ready with something new and improved. Better yet, we need to be ready before it happens – or we may find ourselves with a “new” one-world currency and a “new” one-world government.
Econintersect: “Web of Debt” author Ellen Brown, who is president of The Public Banking Institute, has just published a new book “From Austerity to Prosperity – The Public Bank Solution“. The proposition presented by the book is that publicly owned banks, such as the 94-year old State Bank of North Dakota, are a necessary change to separate public spending from the profiteering of private banks. Ellen Brown is a contributor to Global Economic Intersection.
Follow up:
The author’s book description from Amazon.com:
WHAT WALL STREET DOESN’T WANT YOU TO KNOW. Shock waves from one Wall Street scandal after another have completely disillusioned us with our banking system; yet we cannot do without banks. Nearly all money today is simply bank credit. Economies run on it, and it is created when banks make loans. The main flaw in the current model is that private profiteers have acquired control of the credit spigots. They can cut off the flow, direct it to their cronies, and manipulate it for personal gain at the expense of the producing economy. The benefits of bank credit can be maintained while eliminating these flaws, through a system of banks operated as public utilities, serving the public interest and returning their profits to the public. This book looks at the public bank alternative, and shows with examples from around the world and through history that it works admirably well, providing the key to sustained high performance for the economy and well-being for the people.
Click on the image of the book for more information and to order at Amazon.com.
According to a Bloomberg article which can be read here.
Eric Hardmeyer, chief executive officer of the Bank of North Dakota, said he’s heard from 30 to 40 states asking the same thing: How does the only state-owned bank in the U.S. work?
The financial institution, which opened in 1919 to help North Dakota farmers, has $5 billion in assets and contributed about $340 million in earnings to state coffers in the 12 years through mid-2009.
Lawmakers in other states are modeling proposals on the Bismarck bank as activists protest bailouts for JPMorgan Chase & Co. (JPM) and other financial giants while their customers struggle with foreclosures and unemployment. Supporters say state-run banks, whose deposit base would include tax revenue and other government funds, would have greater control to develop socially minded lending programs favoring average Americans.
“Because of the Occupy Wall Street movement, there is much more of an interest to put in place state-owned banks to serve the public interest,” Marc Armstrong, the executive director of the Sonoma, California-based Public Banking Institute, said in a telephone interview.
“The benefit to commercial businesses is they receive affordable low-cost loans, including some as low as 1 percent per year,” Armstrong said. “The benefit to the state’s public is a more affordable and competitive rate for student loans and home mortgages.”
The Bank of North Dakota offers below-market lending rates as part of a program for beginning farmers. The rate yesterday was 2.25 percent fixed for five years, Hardmeyer said. In contrast, the prime rate, the interest rate that banks charge their most creditworthy customers, was 3.25 percent yesterday.
‘Bottom-Line Driven’
“We have a specific mission that we’re trying to achieve that’s not necessarily bottom-line driven,” Hardmeyer said.
Another difference is that deposits in most conventional commercial banks are guaranteed by the Federal Deposit Insurance Corp., while the North Dakota bank’s deposits are backed by the state.
Lawmakers in 13 states, including Massachusetts and California, introduced legislation this year that would create a state-run bank or study the notion, according to the Public Banking Institute, a non-partisan group backing the idea.
State officials are looking for solutions to budget woes after the recession ate away at revenue from sales and income taxes. U.S. states will have to close shortfalls of more than $46 billion in fiscal 2013, according to a June report by the Center on Budget and Policy Priorities, a nonprofit research organization in Washington.
Financial Crisis
“As the financial crisis deepened and there were liquidity issues around the country, our model was looked at a little bit deeper than it ever had been before,” said Hardmeyer, who may be the only bank president in the U.S. who’s also a state employee. “It has been overwhelming at times in terms of the response.”
The U.S. banking industry opposes the idea and is lobbying against it, saying a state-run bank would compete with commercial banks for business and politicize a state’s lending decisions.
“A state-owned bank? Why don’t we just re-label the state capitols the Kremlin?” Camden Fine, president of the Independent Community Bankers of America, a Washington-based trade group that represents more than 5,000 community banks, said in a telephone interview.
“It’s a socialistic idea,” Fine said. “If you get a state-owned bank that is allocating credit, it can slide very quickly into a situation where those in favor get credit and those not in favor don’t get credit.”
Increase Jobs
Arizona Representative John Fillmore, a Republican from Apache Junction who has introduced legislation to create the Bank of Arizona, said he views it as a way his state could increase jobs while bolstering its treasury.
“We would have a bank, just like a regular bank that you see out there, it would have savings accounts and checking accounts,” Fillmore said in a telephone interview. “But its main function would be to give support to the state and to other banks within the state.”
Efforts to pursue the idea have gotten off to a rocky start in Massachusetts and California. In the Bay State, where legislation was introduced to create a Bank of Massachusetts, a commission said the bank would cost $3.6 billion to start and may expose public funds to “unacceptably high risk.”
In California, lawmakers in September agreed to set up a task force to study the idea of a “California Investment Trust” to boost economic development by easing access to credit for California-based businesses, according to the legislative text. Governor Jerry Brown, a 73-year-old Democrat, vetoed the bill. Brown said he didn’t want to create another “blue ribbon” taskforce and suggested the Legislature’s banking committees look at the idea.
Commercial Banks
The California Bankers Association, a Sacramento-based trade group, lobbied against the proposal, saying a state-owned bank would crowd out commercial banks.
“A state bank has the ability to use the enormous resources of the state to nearly monopolize the market and as a result, create an unfair advantage over commercial banks,” Alex Alanis, the association’s vice president of state government relations, said in a May letter to Assemblymember Ben Hueso, who offered the bill.
Hueso, a Democrat from San Diego, said the proposal is aimed at creating a wholesale bank that would lend through commercial banks to businesses and consumers.
Economic Recovery
“Everything that we can do in this state to encourage the flow of finance, of loans, of capital will really help us in our economic recovery,” Hueso said in a telephone interview. Hueso said he will seek a hearing in the banking committees to explore the idea.
“I can see why state legislators, as those in California who passed this measure, would feel this is the right time,” Darrell Duffie, a finance professor at Stanford University’s Graduate School of Business, in Stanford, California, said in a telephone interview.
State-run banks are more likely to be more flexible in their lending relationships with consumers and less likely to engage in proprietary trading and other risky activities by large commercial banks, Duffie said.
“But if one day a lot of the loans that a state-run bank makes go bad, fingers may get pointed and people may change their mind about whether this is such a great idea,” Duffie said.
To contact the reporter on this story: Alison Vekshin in San Francisco at [email protected].
To contact the editor responsible for this story: Mark Tannenbaum at [email protected].
Eric Hardmeyer, chief executive officer of the Bank of North Dakota, said he’s heard from 30 to 40 states asking the same thing: How does the only state-owned bank in the U.S. work?
The financial institution, which opened in 1919 to help North Dakota farmers, has $5 billion in assets and contributed about $340 million in earnings to state coffers in the 12 years through mid-2009.
Lawmakers in other states are modeling proposals on the Bismarck bank as activists protest bailouts for JPMorgan Chase & Co. (JPM) and other financial giants while their customers struggle with foreclosures and unemployment. Supporters say state-run banks, whose deposit base would include tax revenue and other government funds, would have greater control to develop socially minded lending programs favoring average Americans.
“Because of the Occupy Wall Street movement, there is much more of an interest to put in place state-owned banks to serve the public interest,” Marc Armstrong, the executive director of the Sonoma, California-based Public Banking Institute, said in a telephone interview.
“The benefit to commercial businesses is they receive affordable low-cost loans, including some as low as 1 percent per year,” Armstrong said. “The benefit to the state’s public is a more affordable and competitive rate for student loans and home mortgages.”
The Bank of North Dakota offers below-market lending rates as part of a program for beginning farmers. The rate yesterday was 2.25 percent fixed for five years, Hardmeyer said. In contrast, the prime rate, the interest rate that banks charge their most creditworthy customers, was 3.25 percent yesterday.
‘Bottom-Line Driven’
“We have a specific mission that we’re trying to achieve that’s not necessarily bottom-line driven,” Hardmeyer said.
Another difference is that deposits in most conventional commercial banks are guaranteed by the Federal Deposit Insurance Corp., while the North Dakota bank’s deposits are backed by the state.
Lawmakers in 13 states, including Massachusetts and California, introduced legislation this year that would create a state-run bank or study the notion, according to the Public Banking Institute, a non-partisan group backing the idea.
State officials are looking for solutions to budget woes after the recession ate away at revenue from sales and income taxes. U.S. states will have to close shortfalls of more than $46 billion in fiscal 2013, according to a June report by the Center on Budget and Policy Priorities, a nonprofit research organization in Washington.
Financial Crisis
“As the financial crisis deepened and there were liquidity issues around the country, our model was looked at a little bit deeper than it ever had been before,” said Hardmeyer, who may be the only bank president in the U.S. who’s also a state employee. “It has been overwhelming at times in terms of the response.”
The U.S. banking industry opposes the idea and is lobbying against it, saying a state-run bank would compete with commercial banks for business and politicize a state’s lending decisions.
“A state-owned bank? Why don’t we just re-label the state capitols the Kremlin?” Camden Fine, president of the Independent Community Bankers of America, a Washington-based trade group that represents more than 5,000 community banks, said in a telephone interview.
“It’s a socialistic idea,” Fine said. “If you get a state-owned bank that is allocating credit, it can slide very quickly into a situation where those in favor get credit and those not in favor don’t get credit.”
Increase Jobs
Arizona Representative John Fillmore, a Republican from Apache Junction who has introduced legislation to create the Bank of Arizona, said he views it as a way his state could increase jobs while bolstering its treasury.
“We would have a bank, just like a regular bank that you see out there, it would have savings accounts and checking accounts,” Fillmore said in a telephone interview. “But its main function would be to give support to the state and to other banks within the state.”
Efforts to pursue the idea have gotten off to a rocky start in Massachusetts and California. In the Bay State, where legislation was introduced to create a Bank of Massachusetts, a commission said the bank would cost $3.6 billion to start and may expose public funds to “unacceptably high risk.”
In California, lawmakers in September agreed to set up a task force to study the idea of a “California Investment Trust” to boost economic development by easing access to credit for California-based businesses, according to the legislative text. Governor Jerry Brown, a 73-year-old Democrat, vetoed the bill. Brown said he didn’t want to create another “blue ribbon” taskforce and suggested the Legislature’s banking committees look at the idea.
Commercial Banks
The California Bankers Association, a Sacramento-based trade group, lobbied against the proposal, saying a state-owned bank would crowd out commercial banks.
“A state bank has the ability to use the enormous resources of the state to nearly monopolize the market and as a result, create an unfair advantage over commercial banks,” Alex Alanis, the association’s vice president of state government relations, said in a May letter to Assemblymember Ben Hueso, who offered the bill.
Hueso, a Democrat from San Diego, said the proposal is aimed at creating a wholesale bank that would lend through commercial banks to businesses and consumers.
Economic Recovery
“Everything that we can do in this state to encourage the flow of finance, of loans, of capital will really help us in our economic recovery,” Hueso said in a telephone interview. Hueso said he will seek a hearing in the banking committees to explore the idea.
“I can see why state legislators, as those in California who passed this measure, would feel this is the right time,” Darrell Duffie, a finance professor at Stanford University’s Graduate School of Business, in Stanford, California, said in a telephone interview.
State-run banks are more likely to be more flexible in their lending relationships with consumers and less likely to engage in proprietary trading and other risky activities by large commercial banks, Duffie said.
“But if one day a lot of the loans that a state-run bank makes go bad, fingers may get pointed and people may change their mind about whether this is such a great idea,” Duffie said.
To contact the reporter on this story: Alison Vekshin in San Francisco at [email protected].
To contact the editor responsible for this story: Mark Tannenbaum at [email protected].
Eric Hardmeyer, chief executive officer of the Bank of North Dakota, said he’s heard from 30 to 40 states asking the same thing: How does the only state-owned bank in the U.S. work?
The financial institution, which opened in 1919 to help North Dakota farmers, has $5 billion in assets and contributed about $340 million in earnings to state coffers in the 12 years through mid-2009.
Lawmakers in other states are modeling proposals on the Bismarck bank as activists protest bailouts for JPMorgan Chase & Co. (JPM) and other financial giants while their customers struggle with foreclosures and unemployment. Supporters say state-run banks, whose deposit base would include tax revenue and other government funds, would have greater control to develop socially minded lending programs favoring average Americans.
“Because of the Occupy Wall Street movement, there is much more of an interest to put in place state-owned banks to serve the public interest,” Marc Armstrong, the executive director of the Sonoma, California-based Public Banking Institute, said in a telephone interview.
“The benefit to commercial businesses is they receive affordable low-cost loans, including some as low as 1 percent per year,” Armstrong said. “The benefit to the state’s public is a more affordable and competitive rate for student loans and home mortgages.”
The Bank of North Dakota offers below-market lending rates as part of a program for beginning farmers. The rate yesterday was 2.25 percent fixed for five years, Hardmeyer said. In contrast, the prime rate, the interest rate that banks charge their most creditworthy customers, was 3.25 percent yesterday.
‘Bottom-Line Driven’
“We have a specific mission that we’re trying to achieve that’s not necessarily bottom-line driven,” Hardmeyer said.
Another difference is that deposits in most conventional commercial banks are guaranteed by the Federal Deposit Insurance Corp., while the North Dakota bank’s deposits are backed by the state.
Lawmakers in 13 states, including Massachusetts and California, introduced legislation this year that would create a state-run bank or study the notion, according to the Public Banking Institute, a non-partisan group backing the idea.
State officials are looking for solutions to budget woes after the recession ate away at revenue from sales and income taxes. U.S. states will have to close shortfalls of more than $46 billion in fiscal 2013, according to a June report by the Center on Budget and Policy Priorities, a nonprofit research organization in Washington.
Financial Crisis
“As the financial crisis deepened and there were liquidity issues around the country, our model was looked at a little bit deeper than it ever had been before,” said Hardmeyer, who may be the only bank president in the U.S. who’s also a state employee. “It has been overwhelming at times in terms of the response.”
The U.S. banking industry opposes the idea and is lobbying against it, saying a state-run bank would compete with commercial banks for business and politicize a state’s lending decisions.
“A state-owned bank? Why don’t we just re-label the state capitols the Kremlin?” Camden Fine, president of the Independent Community Bankers of America, a Washington-based trade group that represents more than 5,000 community banks, said in a telephone interview.
“It’s a socialistic idea,” Fine said. “If you get a state-owned bank that is allocating credit, it can slide very quickly into a situation where those in favor get credit and those not in favor don’t get credit.”
Increase Jobs
Arizona Representative John Fillmore, a Republican from Apache Junction who has introduced legislation to create the Bank of Arizona, said he views it as a way his state could increase jobs while bolstering its treasury.
“We would have a bank, just like a regular bank that you see out there, it would have savings accounts and checking accounts,” Fillmore said in a telephone interview. “But its main function would be to give support to the state and to other banks within the state.”
Efforts to pursue the idea have gotten off to a rocky start in Massachusetts and California. In the Bay State, where legislation was introduced to create a Bank of Massachusetts, a commission said the bank would cost $3.6 billion to start and may expose public funds to “unacceptably high risk.”
In California, lawmakers in September agreed to set up a task force to study the idea of a “California Investment Trust” to boost economic development by easing access to credit for California-based businesses, according to the legislative text. Governor Jerry Brown, a 73-year-old Democrat, vetoed the bill. Brown said he didn’t want to create another “blue ribbon” taskforce and suggested the Legislature’s banking committees look at the idea.
Commercial Banks
The California Bankers Association, a Sacramento-based trade group, lobbied against the proposal, saying a state-owned bank would crowd out commercial banks.
“A state bank has the ability to use the enormous resources of the state to nearly monopolize the market and as a result, create an unfair advantage over commercial banks,” Alex Alanis, the association’s vice president of state government relations, said in a May letter to Assemblymember Ben Hueso, who offered the bill.
Hueso, a Democrat from San Diego, said the proposal is aimed at creating a wholesale bank that would lend through commercial banks to businesses and consumers.
Economic Recovery
“Everything that we can do in this state to encourage the flow of finance, of loans, of capital will really help us in our economic recovery,” Hueso said in a telephone interview. Hueso said he will seek a hearing in the banking committees to explore the idea.
“I can see why state legislators, as those in California who passed this measure, would feel this is the right time,” Darrell Duffie, a finance professor at Stanford University’s Graduate School of Business, in Stanford, California, said in a telephone interview.
State-run banks are more likely to be more flexible in their lending relationships with consumers and less likely to engage in proprietary trading and other risky activities by large commercial banks, Duffie said.
“But if one day a lot of the loans that a state-run bank makes go bad, fingers may get pointed and people may change their mind about whether this is such a great idea,” Duffie said.
To contact the reporter on this story: Alison Vekshin in San Francisco at [email protected].
To contact the editor responsible for this story: Mark Tannenbaum at [email protected].