State bank update

We post this article by Ellen Brown to respond to a comment from a reader expressing great concern for the whole Western financial system. In this piece, Brown focuses on another pernicious aspect of interest and banking -- why banks are not lending to businesses, particularly small businesses, other banks, and to individuals.
Below, we have added the text of California Assembly Bill 750 (Hueso, D-San Diego) to create "the investment trust blue ribbon task force to consider the viability of establishing the California Investment Trust, which would be a state bank receiving deposits of state funds." Authored by a freshman legislator with a lot of experience in the financial side of local government, at first glance AB 750 looks too timid to survive, but perhaps the only way it can make it onto the table is with a consensus building approach. We hope Assemblyman Hueso gets a bill creating a sensible state bank passed and signed by the governor before he is termed out of the Legislature. As we see it, the present risk to the idea is that the blue=ribbon commitee will be composed of a majority of reprresentatives of interests dead set against a state bank, who strangle the baby in its blue ribbon crib. 
There is only one state bank in the country, the Bank of North Dakota. Brown discusses its current status and activity below. The BND was established in 1919 at a time when, immediately following the end of World War I, the Federal Reserve, only six years old at the time, drastically raised the prime interest rate, interfering so greatly with the ability to borrow and lend that it precipitated a sharp recession in 1920. As usual, agriculture -- North Dakota is the nation's top wheat producing state -- feels recessions first and climbs out of downturns last.
Brown argues that, ninety-two years later, the Federal Reserve's policy is equally wrong and destructive, although apparently the opposite of its approach in 1919.
All in all, compared with listening to high speed railroad propaganda ("Jobs Jobs Jobs") and observing our local mayor and downtown real estate speculators slobber over the chance to make another killing from public largesse, contemplating the future of a state bank is a more positive and hopeful enterprise...Common Good-wise. Sooner or later, the state will grow tired with little Merced's outstanding municipal greed. The city won the great prize of a 10th University of California campus, which it parlayed into the most irresponsible building boom in the state. Now it can be counted on to be a constant babbling booster of high speed rail because a station in Merced would redeem its crumbling downtown area, replacing the core of the typical Valley town with commuter condos. At the moment however, in its painful growing period, Merced was recently ranked by Forbes Magazine the worst place to do business in a list of 200 metro regions in the nation. And this says nothing about the disruption to farming and the loss of irrigated farmland and yet another railroad -- and this one strictly for passengers -- runs right through the most productive farming area in the nation.
If the leadership of a region has no vision, all you can do is present them something new to think about and hope to distract them from the rut of speculative real estate bubbles.What about creating permanent workplaces -- rather than boom-or-bust and seasonal jobs -- the old-fashioned way, by investing in small businesses, by supporting the business on Main Street rather than bulldoZing it for little boxes to house commuters zipping off to the coast daily on a Chinese bullet train, leaving construction workers behind and out of a job.
"Bedroom communities" destroy community. Look around. 
Badlands Journal editorial board

7-15-11
Global Research
Why Banks Aren’t Lending: The Silent Liquidity Squeeze
by Ellen Brown
http://www.globalresearch.ca/index.php?context=va&aid=25650 
Global Research, July 15, 2011
Web of Debt 
Why aren’t banks lending to local businesses?  The Fed’s decision to pay interest on $1.6 trillion in “excess” reserves is a chief suspect.
Where did all the jobs go?  Small and medium-sized businesses are the major source of new job creation, and they are not hiring.  Startup businesses, which contribute a fifth of the nation’s new jobs, often can’t even get off the ground.  Why? 
In a June 30 article in the Wall Street Journal titled “Smaller Businesses Seeking Loans Still Come Up Empty,” Emily Maltby reported that business owners rank access to capital as the most important issue facing them today; and only 17% of smaller businesses said they were able to land needed bank financing.  Businesses have to pay for workers and materials before they can get paid for the products they produce, and for that they need bank credit; but they are reporting that their credit lines are being cut.  They are being pushed instead into credit card accounts that average 16 percent interest, more than double the rate of the average business loan.  It is one of many changes in banking trends that have been very lucrative for Wall Street banks but are killing local businesses.
Why banks aren’t lending is a matter of debate, but the Fed’s decision to pay interest on bank reserves is high on the list of suspects.  Bruce Bartlett, writing in the Fiscal Times in July 2010, observed:
Economists are divided on why banks are not lending, but increasingly are focusing on a Fed policy of paying interest on reserves — a policy that began, interestingly enough, on October 9, 2008, at almost exactly the moment when the financial crisis became acute. . .  
Historically, the Fed paid banks nothing on required reserves. This was like a tax equivalent to the interest rate banks could have earned if they had been allowed to lend such funds. But in 2006, the Fed requested permission to pay interest on reserves because it believes that it would help control the money supply should inflation reappear. 
. . . [M]any economists believe that the Fed has unwittingly encouraged banks to sit on their cash and not lend it by paying interest on reserves.
At one time, banks collected deposits from their own customers and stored them for their own liquidity needs, using them to back loans and clear outgoing checks.  But today banks typically borrow (or “buy”) liquidity, either from other banks, from the money market, or from the commercial paper market.  The Fed’s payment of interest on reserves competes with all of these markets for ready-access short-term funds, creating a shortage of the liquidity that banks need to make loans. 

By inhibiting interbank lending, the Fed appears to be creating a silent “liquidity squeeze” -- the same sort of thing that brought on the banking crisis of September 2008.  According to Jeff Hummel, associate professor of economics at San Jose State University, it could happen again.  He warns that paying interest on reserves “may eventually rank with the Fed's doubling of reserve requirements in the 1930s and bringing on the recession of 1937 within the midst of the Great Depression.” 

The Travesty of the $1.6 Trillion in “Excess Reserves”
The bank bailout and the Federal Reserve’s two “quantitative easing” programs were supposedly intended to keep credit flowing to the local economy; but despite trillions of dollars thrown at Wall Street banks, these programs have succeeded only in producing mountains of “excess reserves” that are now sitting idle in Federal Reserve bank accounts.  A stunning $1.6 trillion in excess reserves have accumulated since the collapse of Lehman Brothers on September 15, 2008. 
The justification for TARP -- the Trouble Asset Relief Program that subsidized the nation’s largest banks -- was that it was necessary to unfreeze credit markets.  The contention was that banks were refusing to lend to each other, cutting them off from the liquidity that was essential to the lending business.  But an MIT study reported in September 2010 showed that immediately after the Lehman collapse, the interbank lending markets were actually working.  They froze, not when Lehman died, but when the Fed started paying interest on excess reserves in October 2008.  According to the study, as summarized in The Daily Bail:
. . . [T]he NY Fed's own data show that interbank lending during the period from September to November did not "freeze," collapse, melt down or anything else.  In fact, every single day throughout this period, hundreds of billions were borrowed and paid back.  The decline in daily interbank lending came only when the Fed ballooned its balance sheet and started paying interest on excess reserves. 
On October 9, 2008, the Fed began paying interest, not just on required bank reserves (amounting to 10% of deposits for larger banks), but on “excess” reserves.  Reserve balances immediately shot up, and they have been going up almost vertically ever since. 
By March 2011, interbank loans outstanding were only one-third their level in May 2008, before the banking crisis hit.  And on June 29, 2011, the Fed reported excess reserves of nearly $1.57 trillion – 20 times what the banks needed to satisfy their reserve requirements.   
Why Pay Interest on Reserves?
Why the Fed decided to pay interest on reserves is a complicated question, but it was evidently a desperate attempt to keep control of “monetary policy.”  The Fed theoretically controls the money supply by controlling the Fed funds rate.  This hasn’t worked very well in practice, but neither has anything else, and the Fed is apparently determined to hang onto this last arrow in its regulatory quiver.   
In an effort to salvage a comatose credit market after the Lehman collapse, the Fed set the target rate for Fed funds – the funds that banks borrow from each other -- at an extremely low 0.25%.  Paying interest on reserves at that rate was intended to ensure that the Fed funds rate did not fall below the target.  The reasoning was that banks would not lend their reserves to other banks for less, since they could get a guaranteed 0.25% from the Fed.  The medicine worked, but it had the adverse side effect of killing the Fed funds market, on which local lenders rely for their liquidity needs. 
It has been argued that banks do not need to get funds from each other, since they are now awash in reserves; but these reserves are not equally distributed.  The 25 largest U.S. banks account for over half of aggregate reserves, with 21% of reserves held by just 3 banks; and the largest banks have cut back on small business lending by over 50%.  Large Wall Street banks have more lucrative things to do with the very cheap credit made available by the Fed that to lend it to businesses and consumers, which has become a risky and expensive business with the imposition of higher capital requirements and tighter regulations. 
In any case, as noted in an earlier article, the excess reserves from the QE2 funds have accumulated in foreign rather than domestic banks.  John Mason, Professor of Finance at Penn State University and a former senior economist at the Federal Reserve, wrote in a June 27 blog that despite QE2:
Cash assets at the smaller [U.S.] banks remained relatively flat . . . . Thus, the reserves the Fed was pumping into the banking system were not going into the smaller banks. . . . 
[B]usiness loans continue to “tank” at the smaller banking institutions.

Local Business Lending Depends on Ready Access to Liquidity
Without access to the interbank lending market, local banks are reluctant to extend business credit lines.  The reason was explained by economist Ronald McKinnon in a Wall Street Journal article in May:
Banks with good retail lending opportunities typically lend by opening credit lines to nonbank customers. But these credit lines are open-ended in the sense that the commercial borrower can choose when—and by how much—he will actually draw on his credit line. This creates uncertainty for the bank in not knowing what its future cash positions will be. An illiquid bank could be in trouble if its customers simultaneously decided to draw down their credit lines.
If the retail bank has easy access to the wholesale interbank market, its liquidity is much improved. To cover unexpected liquidity shortfalls, it can borrow from banks with excess reserves with little or no credit checks. But if the prevailing interbank lending rate is close to zero (as it is now), then large banks with surplus reserves become loath to part with them for a derisory yield. And smaller banks, which collectively are the biggest lenders to SMEs [small and medium-sized enterprises], cannot easily bid for funds at an interest rate significantly above the prevailing interbank rate without inadvertently signaling that they might be in trouble. Indeed, counterparty risk in smaller banks remains substantial as almost 50 have failed so far this year.
The local banks could turn to the Fed’s discount window for loans, but that too could signal that the banks were in trouble; and for weak banks, the Fed’s discount window may be closed.  Further, the discount rate is triple the Fed funds rate. 
As Warren Mosler, author of The 7 Deadly Innocent Frauds of Economic Policy, points out, bank regulators have made matters worse by setting limits on the amount of “wholesale” funding small banks can do.  That means they are limited in the amount of liquidity they can buy (e.g. in the form of CDs).  A certain percentage of a bank’s deposits must be “retail” deposits – the deposits of their own customers.  This forces small banks to compete in a tight market for depositors, driving up their cost of funds and making local lending unprofitable.  Mosler maintains that the Fed could fix this problem by (a) lending Fed funds as needed to all member banks at the Fed funds rate, and (b) dropping the requirement that a percentage of bank funding be retail deposits.    
Finding Alternatives to a Failed Banking Model
Paying interest on reserves was intended to prevent “inflation,” but it is having the opposite effect, contracting the money and credit that are the lifeblood of a functioning economy.  The whole economic model is wrong.  The fear of price inflation has prevented governments from using their sovereign power to create money and credit to serve the needs of their national economies.  Instead, they must cater to the interests of a private banking industry that profits from its monopoly power over those essential economic tools. 
Whether by accident or design, federal policymakers still have not got it right.  While we are waiting for them to figure it out, states can nurture and protect their own local economies with publicly-owned banks, on the model of the Bank of North Dakota (BND).  Currently the nation’s only state-owned bank, the BND services the liquidity needs of local banks and keeps credit flowing in the state.  Other benefits to the local economy are detailed in a Demos report by Jason Judd and Heather McGhee titled “Banking on America: How Main Street Partnership Banks Can Improve Local Economies.”  They write:
Alone among states, North Dakota had the wherewithal to keep credit moving to small businesses when they needed it most. BND’s business lending actually grew from 2007 to 2009 (the tightest months of the credit crisis) by 35 percent. . . . [L]oan amounts per capita for small banks in North Dakota are fully 175% higher than the U.S. average in the last five years, and its banks have stronger loan-to-asset ratios than comparable states like Wyoming, South Dakota and Montana.
Fourteen states have now initiated bills to establish state-owned banks or to study their feasibility.  Besides serving local lending needs, state-owned banks can provide cash-strapped states with new revenues, obviating the need to raise taxes, slash services or sell off public assets.
Ellen Brown is an attorney and president of the Public Banking Institute, http://PublicBankingInstitute.org. In Web of Debt, her latest of eleven books, she shows how the power to create money has been usurped from the people, and how we can get it back. Her websites are http://webofdebt.com and http://ellenbrown.com.
------------------------------
7-16-11
BILL NUMBER: AB 750 AMENDED
 BILL TEXT

http://www.leginfo.ca.gov/
 AMENDED IN SENATE  JULY 12, 2011
 AMENDED IN ASSEMBLY  MAY 27, 2011
 AMENDED IN ASSEMBLY  MAY 5, 2011
 AMENDED IN ASSEMBLY  APRIL 25, 2011
 AMENDED IN ASSEMBLY  MARCH 31, 2011
INTRODUCED BY   Assembly Member Hueso
   (Coauthors: Assembly Members Gatto, Roger Hernández, Lara, and
Perea)
    (   Coauthors:   Senators   Evans,
  Hancock,   and Pavley   )
                        FEBRUARY 17, 2011
   An act to add and repeal Division 5 (commencing with Section
64160) of Title 6.7 of the Government Code, relating to finance.

 LEGISLATIVE COUNSEL'S DIGEST

   AB 750, as amended, Hueso. Finance: investment trust blue ribbon
task force.
   The California Constitution provides for the election by the
people of the Treasurer and the Controller. Existing law requires the
Treasurer to receive and keep in the vaults of the treasury or to
deposit in banks or credit unions all moneys belonging to the state,
as specified. Existing law requires the Controller to superintend the
fiscal concerns of the state. Existing law requires the Controller
to audit all claims against the state, and authorizes the Controller
to audit the disbursement of any state money, for correctness,
legality, and for sufficient provisions of law for payment.
   This bill would establish the investment trust blue ribbon task
force to consider the viability of establishing the California
Investment Trust, which would be a state bank receiving deposits of
state funds. The task force would be required to consider how the
investment trust could strengthen economic and community development,
provide financial stability to  individuals and
businesses, reduce the cost paid by state government for banking
services, and provide for excess earnings of the trust to be used to
supplement General Fund purposes. The bill would establish the
membership of the task force, which would include the Secretary of
Business, Transportation and Housing, or his or her designee, and
specified individuals with a background in finance appointed by the
Legislature, and the Governor, Controller, and Treasurer, or their
designees, and would require the task force to be staffed
from existing resources of the Business, Transportation and Housing
Agency   by an organization selected by the task force
that is a nonprofit corporation, or other private corporation that
has specified   expertise, including expertise in public
finance and public institutions models  . The bill would require
the task force to report to the Legislature by December 1, 2012, on
specified issues relative to the California Investment Trust,
including, among other things, its recommendations relating to the
viability of establishing the trust, as specified. The bill's
provisions would become inoperative, and would be repealed, on
January 1, 2017.
   Vote: majority. Appropriation: no. Fiscal committee: yes.
State-mandated local program: no.

THE PEOPLE OF THE STATE OF CALIFORNIA DO ENACT AS FOLLOWS:
  SECTION 1.  The Legislature finds and declares all of the
following:
   (a) California communities have suffered greatly since the
financial crisis of 2007. During the last several years, monthly
unemployment levels have remained above 10 percent leaving millions
of Californians out of work. Bankruptcies among small businesses
 and individuals  are up, capital markets are tight,
and local communities have limited resources to address their
economic and community development challenges.
   (b) While Californians have been especially hard hit in this
recession, residents of other states have also suffered. In
responding to the sluggish capital markets, several states, including
Maine, Oregon, Rhode Island, and Washington, are examining the
appropriateness of creating a state bank.
   (c) The creation of the California Investment Trust could serve to
more effectively meet the financial needs of the state, including,
but not limited to, the following:
   (1) Supporting the economic development of California by
increasing access to capital for businesses in the state.
   (2) Providing financing for housing development, public works
infrastructure, educational infrastructure, student loans, and
community quality of life projects.
   (3) Providing stability to the local financial sector.
   (4) Reducing the cost paid by state government for banking
services.
   (5) Lending capital to banks, credit unions, and nonprofit
community development financial institutions to assist in meeting
their goals of increasing access to capital and providing banking
services.
  SEC. 2.  Division 5 (commencing with Section 64160) is added to
Title 6.7 of the Government Code, to read:
      DIVISION 5.  Investment Trust Blue Ribbon Task Force

   64160.  (a) There is hereby established the investment trust blue
ribbon task force. The task force shall be convened by the Secretary
of Business, Transportation and Housing.
   (b) The task force shall be composed of the following members:
   (1) The Secretary of Business, Transportation and Housing or his
or her designee.
   (2) The Senate Committee on Rules shall appoint  two
individuals   one individual  representing and
having a background in one or more areas of finance, including, but
not limited to,  individuals  working in for-profit
and nonprofit financial and academic institutions,  and
  or working in  economic development
practitioners  .
   (3) The Speaker of the Assembly shall appoint  two
individuals   one individual  representing and
having a background in one or more areas of finance, including, but
not limited to,  individuals  working in for-profit
and nonprofit financial and academic institutions,  and
  or working in  economic development
practitioners  .
   (4) The Governor shall appoint  five   three
 members representing and having a background in one or more
areas of finance, including, but not limited to, individuals working
in for-profit and nonprofit financial and academic institutions, and
economic development practitioners.
   (5) The Controller, Treasurer, and Governor, or their designees,
shall be members of the task force.
   (c) (1) The task force shall choose its chair from among its
membership. The Secretary of Business, Transportation and Housing and
the members of the task force shall convene the initial meeting of
the task force on or before February 1, 2012.
   (2) A quorum shall constitute a majority plus one of the members
serving on and appointed to the task force at the time the meeting is
convened.
   (3) A quorum is not necessary for conducting meetings except for
meetings where the draft report and final report are to be voted
upon.
   (d) The purpose of the task force shall be to consider the
viability of establishing the California Investment Trust, which
would be a state bank receiving deposits of state funds, and to
report to the Legislature pursuant to Section 64161.
   (e) In undertaking its work, the task force shall consider one or
more models for structuring the California Investment Trust. Among
other things, the task force shall do the following:
   (1) Undertake a general assessment of the state's current network
of public and private financial resources for the purpose of
identifying potential areas of state trust focus. Among other
resource issues, the task force shall consider, at a minimum, how a
state trust could be designed to do the following:
   (A) Strengthen the economic and community development needs of
California.
   (B) Provide greater financial stability to  individuals
and  businesses  through its investments in other
financial institutions  .
   (C) Reduce the cost paid by state government for banking services.
   (D) Generate earnings beyond those necessary for continued
operation of the trust, which could be used to supplement the General
Fund.
   (2) Consider the types of financial products that could be offered
to address currently unmet financial needs and more efficiently
deliver existing financial resources and products. The task force
shall take a broad view in assessing individual-, business-, and
community-level financial needs, including, but not limited to,
products that improve access to capital for businesses, farmers,
homeowners, students, the unbanked, and local governments.
   (2) Support a strong private sector financial community that will
provide capital for businesses in California.
   (3) Examine various administrative and operational structures for
organizing a trust, including, but not limited to, boards of
directors, sources of deposits, oversight and audit of financial
activities, and guarantees of financial products.
   (4) Consider options for integrating a state trust model into the
existing state financial resource network, including, but not limited
to, ideas such as lending capital to banks, credit unions, and
nonprofit community development financial institutions.
   (f) (1) The task force shall be staffed by an organization
selected by the task force that shall be a nonprofit corporation or
other private organization that has specific expertise in public
finance and public institutions models and other expertise as
necessary to provide the management, information, analysis, review,
and reporting required to meet the goals of the task force.  The
selection of an organization to staff the task force shall be agreed
to by at least two-thirds of the membership of the task force.
   (2) Appointed task force members shall be reimbursed solely for
the actual travel costs for attending meetings. Costs associated with
state government officials attending meetings shall be paid by the
respective government entities.
   (g) The task force may consult with individuals from the public
and private sector and establish an advisory committee to assist the
task force in creating the report required under Section 64161. If
the task force establishes an advisory committee, the members of the
committee shall not be entitled to any expense reimbursement.
   64161.  (a) The task force shall, pursuant to Section 9795, report
to the Legislature by December 1, 2012.  The report shall
represent the views of a majority of the task force members.
   (b) The report shall address, at a minimum, all of the following:
   (1) A recommendation on the viability of establishing the
California Investment Trust.
   (2) A list of issues and, to the extent determined, findings
relative to the considerations identified in subdivision (e) of
Section 64160.
   (c) To the extent that the task force recommendation is supportive
of the establishment of the California Investment Trust, the task
force shall also provide information on the next steps for
establishing the trust, including, but not limited to,
recommendations on the following:
   (1) The administrative structure of the trust.
   (2) The capital requirements for the trust's initial
capitalization and for ongoing operations.
   (3) How the initial capitalization can be achieved and how
operating costs could be paid.
   (4) Whether the California Investment Trust should be created as a
separate entity or by modifying or expanding the California
Infrastructure and Economic Development Bank. 
   (5) The manner in which the trust should be regulated to protect
the safety and soundness of the institution and its depositors, and
to avoid conflicts of interest that could arise from state regulation
of the trust. 
   (6) The extent to which the trust should be allowed to compete
with retail banking establishments operating in California.
   (4)
    (7)  The oversight of the trust to protect the interests
of the state and the rights of individuals and entities that may
access the products or services, or both, of the trust.
   (5)
    (8)  An outline of transition actions necessary for
establishing the trust.
   (6)
    (9)  A draft of statutory and constitutional changes
that may be necessary to establish the trust.
   (d) The report may include findings from the organization selected
to staff the task force pursuant to subdivision (f) of Section 64160
relative to the information specified in subdivisions (b) and (c),
but shall represent the conclusions and recommendations of the
majority of the task force membership.
   64162.  This division shall become inoperative and is repealed on
January 1, 2017, pursuant to Section 10231.5.