That's what California gets for not following Ellen Brown's advice...
California has over $17 billion on deposit in banks that have refused to honor its IOUs, forcing legislators to accept crippling budget cuts. These austerity measures are unnecessary. If the state were to deposit its money in its own state-owned bank, it could have enough credit to solve its budget crisis with funds to spare. “We make money the old-fashioned way,” said Art Rolnick, chief economist of the Minneapolis Federal Reserve. “We print it.” That works for the federal government’s central bank, but states are forbidden by the Constitution to issue “bills of credit,” a term that has been interpreted to mean the state’s own paper money. “Sacramento is not Washington,” said California Governor Arnold Schwarzenegger in May. “We cannot print our own money.” When legislators could not agree on how to solve the state’s $26.3 billion budget deficit, the Governor therefore did the next best thing: he began paying the bills with IOUs (“I Owe You’s,” or promises to pay bearing interest).
The problem was that most banks declined to honor the IOUs, at least after July 24. “They said something about not wanting to enable the dysfunctional state legislature,” observed a
San Diego Union-Tribune staff writer, “which is kind of funny as the federal government has been enabling the dysfunctional financial sector for almost a year.”
On July 21, California legislators were strong-armed into a
tentative agreement on budget cuts, a forced move that was called “painful” by the Speaker of the Assembly and “devastating” by the executive director of the California State Association of Counties. The cuts involve more job losses, more bleeding of school funds, more closing of facilities. Worse, they will not solve the budget crisis long-term. The state’s economy is expected to continue to deteriorate along with its revenues. But without banks to honor the state’s IOUs, California has no time to negotiate or explore alternatives. There is no “
quick fix,” says UCLA Professor Daniel Mitchell.
Or is there?
More Than One Way to Solve a Budget CrisisAmong the banks rejecting California’s IOUs are six of particular interest: Citibank, Union Bank, Bank of America, Wells Fargo, U.S. Bank, and Westamerica Bank. These banks are interesting because they are
six of the seven depository banks in which the state of California currently deposits its money. (The seventh is Bank of the West, which loyally said it would accept the IOUs indefinitely.)
Banks operate under federal or state charters that grant them special rights and privileges. Chartered banks are endowed with a gift that keeps on giving: they can “leverage” the value of their deposits into anywhere from ten to thirty times that sum in interest-bearing loans. This “multiplier effect” is attested to by
many authorities, including President Obama himself. He said in a speech at Georgetown University on April 14:
“Although there are a lot of Americans who understandably think that government money would be better spent going directly to families and businesses instead of banks – ‘where’s our bailout?,’ they ask – the truth is that a dollar of capital in a bank can actually result in eight or ten dollars of loans to families and businesses, a multiplier effect that can ultimately lead to a faster pace of economic growth.”
The website of
the Federal Reserve Bank of Dallas 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 . . . 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.”
Combine this with another interesting fact: according to the
California Treasurer’s report, as of May 2009 the state had aggregate deposits and investments exceeding $55 billion. Of this sum, $1.1 billion was held in demand deposit accounts (non-interest-bearing accounts allowing unlimited deposits and withdrawals) and $16.5 billion was in NOW accounts (interest-bearing accounts allowing unlimited deposits and withdrawals). According to the Treasurer’s office, the non-interest-bearing demand deposits are held at the seven depository banks named earlier, while the NOW accounts are held at Citibank and Union Bank. Applying a “multiplier effect” of ten to the total sum on deposit at these seven banks ($17.6 billion), the banks collectively have the ability to make
$176 billion in loans. At 5%, $176 billion can generate $8.8 billion in interest for the banks.
Rather than showing their gratitude by reciprocating, however, six of the seven depository banks have refused to honor California’s IOUs. Worse, three of these six actually received federal bailout money from the taxpayers, something that was supposedly done to keep credit flowing to the states and their citizens. Citibank got $45 billion in
bailout money, Wells Fargo got $25 billion, and Bank of America got $45 billion, not to mention guarantees of $300 billion for Citibank and $118 billion for Bank of America. When Governor Schwarzenegger asked for a loan guarantee for a mere
$6 billion to bolster California’s credit rating, on the other hand, he was turned down. Californians compose one-eighth of the nation’s population.
When the state’s appeal for aid was rejected by the banks, California State Treasurer Bill Lockyer said he was “disappointed.” He and other state leaders should show their disappointment with their feet. California could pull its deposits out of those depository banks refusing its IOUs and put them instead in its own state-owned bank, following the lead of North Dakota, which now has the only state-owned bank in the country. Set up in 1919 to escape Wall Street predators, the
Bank of North Dakota has been generating low-interest credit for the state and its residents for nearly a century. North Dakota is one of only
two states (along with Montana) currently able to meet their budgets.
A state-owned bank could be fast-tracked into operation in a matter of weeks. With over $17 billion available to deposit in its own bank, California could create $170 billion or more in credit -- enough not only to meet its budget shortfall but to fund many other much-needed projects; and rather than feeding an ungrateful Wall Street, the bank’s profits would return to the state and its people.
For over a decade, accountant Walter Burien has been trying to rouse the public over what he contends is a massive conspiracy and cover-up, involving trillions of dollars squirreled away in funds maintained at every level of government. His numbers may be disputed, but these funds definitely exist, as evidenced by the Comprehensive Annual Financial Reports (CAFRs) required of every government agency. If they don’t represent a concerted government conspiracy, what are they for? And how can they be harnessed more efficiently to help allay the financial crises of state and local governments?
The Elusive CAFR MoneyBurien is a former commodity trading adviser who has spent many years peering into government books. He notes that the government is composed of 54,000 different state, county, and local government entities, including school districts, public authorities, and the like; and that these entities all keep their financial assets in liquid investment funds, bond financing accounts and corporate stock portfolios. The only income that must be reported in government budgets is that from taxes, fines and fees; but the investments of government entities can be found in official annual reports (CAFRs), which must be filed with the federal government by local, county and state governments. These annual reports show that virtually every U.S. city, county, and state has vast amounts of money stashed away in surplus funds. Burien maintains that these slush funds have been kept concealed from taxpayers, even as taxes are being raised and citizens are being told to expect fewer government services.
It is hard to envision how all the municipal governments hording their excess money in separate funds could be complicit in a massive government conspiracy, but if that is not what is going on, why such an inefficient use of public monies?
A Simpler ExplanationI got a chance to ask that question in April, when I was invited to speak at a conference of Government Finance Officers in Missouri. The friendly public servants at the conference explained that maintaining large “rainy day” funds is simply how local governments must operate. Unlike private businesses, which have bank credit lines they can draw on if they miscalculate their expenses, local governments are required by law to balance their budgets; and if they come up short, public services and government payrolls may be frozen until the voters get around to approving a new bond issue. This has actually happened, bringing local government to a standstill. In emergencies, government officials can try to borrow short-term through “certificates of participation” or tax participation loans, but the interest rates are prohibitively high; and in today’s tight credit market, finding willing lenders is difficult.
To avoid those unpredictable contingencies, municipal governments will keep a cushion of from 20% to 75% more than their budgets actually require. This money is invested, but not necessarily lucratively. One finance officer, for example, said that her city had just bid out $2 million as a 30-day certificate of deposit (CD) to two large banks at a meager annual interest of 0.11%. It was a nice spread for the banks, which could leverage the money into loans at 6% or so; but it was a pretty sparse deal for the city.
Meanwhile, Back in CaliforniaThat was in Missouri, but the figures I was particularly interested were for my own state of California, which was struggling with a budget deficit of
$26.3 billion as of April 2010. Yet the State Treasurer’s website says that he manages a
Pooled Money Investment Account (PMIA) [.pdf] tallying in at nearly $71 billion as of the same date, including a Local Agency Investment Fund (LAIF) of $24 billion. Why isn’t this money being used toward the state’s deficit? The Treasurer’s answer to this question, which he evidently gets frequently, is that legislation forbids it. His
website states:
“Can the State borrow LAIF dollars to resolve the budget deficit?
“No. California Government Code 16429.3 states that monies placed with the Treasurer for deposit in the LAIF by cities, counties, special districts, nonprofit corporations, or qualified quasi-governmental agencies shall not be subject to either of the following:
“(a) Transfer or loan pursuant to Sections 16310, 16312, or 16313.
“(b) Impoundment or seizure by any state official or state agency.”
The non-LAIF money in the pool can’t be spent either. It can be borrowed, but it has to be paid back. When Governor Schwarzenegger tried to raid the Public Transportation Account for the state budget, the California Transit Association took him to court and
won. The Third District Court of Appeals ruled in June 2009 that diversions from the Public Transportation Account to fill non-transit holes in the General Fund violated a series of statutory and constitutional amendments enacted by voters via four statewide initiatives dating back to 1990.
In short, the use of these funds for the state budget has been blocked
by the voters themselves. Bond issues are approved for particular purposes. When excess funds are collected, they are not handed over to the State toward next year’s budget. They just sit idly in an earmarked fund, drawing a modest interest.
What’s Wrong with This Picture?California’s budget problems have caused its credit rating to be downgraded to just above that of Greece, driving the state’s interest tab skyward. In November 2009, the state sold 30-year taxable securities carrying an interest rate of
7.26%. Yet California has
never defaulted on its bonds. Meanwhile, the too-big-to-fail banks, which would have defaulted on
hundreds of billions of dollars of debt if they had not been bailed out by the states and their citizens, are able to borrow from each other at the extremely low federal funds rate, currently set at 0 to .25% (one quarter of one percent). The banks are also paying the states quite minimal rates for the use of their public monies, and turning around and relending this money, leveraged many times over, to the states and their citizens at much higher rates. That is assuming they lend at all, something they are increasingly reluctant to do, since speculating with the money is more lucrative, and investing it in federal securities is more secure.
Private banks clearly have the upper hand in this game. Local governments have been forced to horde funds in very inefficient ways, building excessive reserves while slashing services, because they do not have the extensive credit lines available to the private banking system. States cannot easily incur new debt without voter approval, a process that is cumbersome, time-consuming and uncertain. Banks, on the other hand, need to keep only the slimmest of reserves, because they are backstopped by a central bank with the power to create all the reserves necessary for its member banks, as well as by Congress and the taxpayers themselves, who have been arm-twisted into repeated bailouts of the Wall Street behemoths.
How the CAFR Money Could Be Used Without Spending ItCalifornia, then, is in the anomalous position of being $26 billion in the red and plunging toward bankruptcy, while it has over $70 billion stashed away in an investment pool that it cannot touch. Those are just the funds managed by the Treasurer. According to California’s latest CAFR, the California Public Employees’ Retirement Fund (CalPERS) has total investments of
$360 billion, including nearly $144 billion in “equity securities” and $37 billion in “private equity.” See the State of California
Comprehensive Annual Financial Report [.pdf] for the Fiscal Year Ended June 30, 2009, pages 83-84.
This money cannot be
spent, but it can be invested -- and it can be invested not just in conservative federal securities but in equity, or stocks. Rather than turning this hidden gold mine over to Wall Street banks to earn a very meager interest, California could leverage its excess funds itself, turning the money into much-needed low-interest credit for its own use. How? It could do this by
owning its own bank.
Only one state currently does this -- North Dakota. North Dakota is also the
only state projected to have a budget surplus by 2011. It has not fallen into the Wall Street debt trap afflicting other states, because it has been able to generate its own credit through its own state-owned Bank of North Dakota (BND).
An investment in the State Bank of California would not be at risk unless the bank became insolvent, a highly unlikely result since the state has the power to tax. In North Dakota, the BND is a
dba of the state itself: it is set up as “the State of North Dakota
doing business as the Bank of North Dakota.” That means the bank cannot go bankrupt unless the state goes bankrupt.
The capital requirement for bank loans is a complicated matter, but it generally works out to be about 7%. (According to Standard & Poor’s, the worldwide
average risk-adjusted capital ratio stood at 6.7 per cent as of June 30, 2009; but for some major U.S. banks it was much lower: Citigroup's was 2.1 per cent; Bank of America’s was 5.8 per cent.) At 7%, $7 of capital can back $100 in loans. Thus if $7 billion in CAFR funds were invested as capital in a California state development bank, the bank could generate $100 billion in loans.
This $100 billion credit line would allow California to finance its $26 billion deficit at very minimal interest rates, with $74 billion left over for infrastructure and other sorely needed projects. Studies have
shown that eliminating the interest burden can cut the cost of public projects in half. The loans could be repaid from the profits generated by the projects themselves. Public transportation, low-cost housing, alternative energy sources and the like all generate fees. Meanwhile, the jobs created by these projects would produce additional taxes and stimulate the economy. Commercial loans could also be made, generating interest income that would return to state coffers.
Building a Deposit BaseTo start a bank requires not just capital but deposits. Banks can
create all the loans they can find creditworthy borrowers for, up to the limit of their capital base; but when the loans leave the bank as checks, the bank needs to replace the deposits taken from its reserve pool in order for the checks to clear. Where would a state-owned bank get the deposits necessary for this purpose?
In North Dakota, all the state’s revenues are deposited in the BND by law. Compare California, which has expected revenues for 2010-11 of
$89 billion [.pdf]. The
Treasurer’s website [.pdf] reports that as of June 30, 2009, the state held over $18 billion on deposit as demand accounts and demand NOW accounts (basically demand accounts carrying a very small interest). These deposits were held in seven commercial banks, most of them Wall Street banks: Bank of America, Union Bank, Bank of the West, U.S. Bank, Wells Fargo Bank, Westamerica Bank, and Citibank. Besides these deposits, the $64 billion or so left in the Treasurer’s investment pool could be invested in State Bank of California CDs. Again, most of the bank CDs in which these funds are now invested are
Wall Street or foreign banks [.pdf]. Many private depositors would no doubt choose to bank at the State Bank of California as well, keeping California’s money in California. There is already a movement afoot to transfer funds out of Wall Street banks into local banks.
While the new state-owned bank is waiting to accumulate sufficient deposits to clear its outgoing checks, it can do what other startup banks do – borrow deposits from the interbank lending market at the very modest federal funds rate (0 to .25%).
To avoid hurting California’s local banks, any state monies held on deposit with local banks could remain there, since the State Bank of California should have plenty of potential deposits without these funds. In North Dakota, local banks are not only not threatened by the BND but are actually served by it, since the BND partners with them, engaging in “participation loans” that help local banks with their capital requirements.
Taking Back the Money PowerWe have too long delegated the power to create our money and our credit to private profiteers, who have plundered and exploited the privilege in ways that are increasingly being exposed in the media. Wall Street may
own Congress, but it does not yet own the states. We can take the money power back at the state level, by setting up our own publicly-owned banks. We can “spend” our money while conserving it, by leveraging it into the credit urgently needed to get the wheels of local production turning once again.
