Escape
from Pottersville: The North Dakota Model for Capitalizing
Community Banks
11 January 2010By Ellen Brown
Where can our floundering community banks get the
capital to make room on their books for substantial
new loans? An innovative answer is provided by the
state of North Dakota.
Arianna Huffington just posted an article on the
Huffington Post that has sparked a remarkable wave of
interest, evoking nearly 5,000 comments in less than a
week. Called “Move Your Money,” the article maintains
that we can get credit flowing again on Main Street by
moving our money out of the Wall Street behemoths and
into our local community banks. This solution has been
suggested before, but Arianna added the very appealing
draw of a video clip featuring Jimmy Stewart in It’s a
Wonderful Life. In the holiday season, we are all
hungry for a glimpse of that wonderful movie that used
to be a mainstay of Christmas, showing daily
throughout the holidays. The copyright holders have
suddenly gotten very Scrooge-like and are allowing it
to be shown only once a year on NBC. Whatever their
motives, Wall Street no doubt approves of this
restriction, since the movie continually reminded
viewers of the potentially villainous nature of Big
Banking.
Pulling our money out of Wall Street and putting it
into our local community banks is an idea with
definite popular appeal. Unfortunately, however, this
move alone won't be sufficient to strengthen the small
banks. Community banks lack capital – money that
belongs to the bank -- and the deposits of customers
don’t count as capital. Rather, they represent
liabilities of the bank, since the money has to be
available for the depositors on demand. Bank “capital”
is the money paid in by investors plus accumulated
retained earnings. It is the net worth of the bank, or
assets minus liabilities. Lending ability is limited
by a bank’s assets, not its deposits; and today,
investors willing to build up the asset base of small
community banks are scarce, due to the banks’
increasing propensity to go bankrupt.
It’s a Wonderful Life actually illustrated the
weakness of local community banking without major
capital backup. George Bailey’s bank was a savings and
loan, which lent out the deposits of its customers. It
“borrowed short and lent long,” meaning it took in
short-term deposits and made long-term mortgage loans
with them. When the customers panicked and all came
for their deposits at once, the money was not to be
had. George’s neighbors and family saved the day by
raiding their cookie jars, but that miracle cannot be
counted on outside Hollywood.
The savings and loan model collapsed completely in the
1980s. Since then, all banks have been allowed to
create credit as needed just by writing it as loans on
their books, a system called “fractional reserve”
lending. Banks can do this up to a certain limit,
which used to be capped by a “reserve requirement” of
10%. That meant the bank had to have on hand a sum
equal to 10% of its deposits, either in its vault as
cash or in the bank’s reserve account at its local
Federal Reserve bank. But many exceptions were carved
out of the rule, and the banks devised ways to get
around it.
That was when the Bank for International Settlements
stepped in and imposed “capital requirements.” The BIS
is the “central bankers’ central bank” in Basel,
Switzerland. In 1988, its Basel Committee on Banking
Supervision published a set of minimal requirements
for banks, called Basel I. No longer would “reserves”
in the form of other people’s deposits be sufficient
to cover loan losses. The Committee said that loans
had to be classified according to risk, and that the
banks had to maintain real capital – their own money –
generally equal to 8% of these “risk-weighted” assets.
Half of this had to be “Tier 1" capital, completely
liquid assets in the form of equity owned by
shareholders – funds paid in by investors plus
retained earnings. The other half could include such
things as unencumbered real estate and loans, but they
still had to be the bank’s own assets, not the
depositors’.
For a number of years, U.S. banks managed to get
around this rule too. They did it by removing loans
from their books, bundling them up as “securities,”
and selling them off to investors. But when the
"shadow lenders" – the investors buying the bundled
loans – realized these securities were far more risky
than alleged, they exited the market; and they aren’t
expected to return any time soon. That means banks are
now stuck with their loans; and if the loans go into
default, as many are doing, the assets of the banks
must be marked down. The banks can then become “zombie
banks” (unable to make new loans) or can go bankrupt
and have to close their doors.
The final blow to the easy credit provided by U.S.
banks came with another stricture on capital, called
Basel II. It manifested in the U.S. as the
“mark-to-market” rule, which required a bank’s loan
portfolio to be valued at what it could be sold for
(the “market”), not its original book value. In
today’s unfavorable market, that meant a huge drop in
asset value for the banks, dramatically reducing their
ability to generate new loans. When the announcement
was made in November 2007 that this rule was going to
be imposed on U.S. banks, credit dried up and the
stock market plunged. The market did not begin to
recover until 2009, when the rule was largely lifted.
However, on December 17, 2009, the Basel Committee
announced plans to impose even tighter capital
requirements. The foreseeable result is the collapse
of yet more community banks and the drying up of yet
more credit on Main Street.
Anchoring Community Banks to State-owned Banks
Where can our floundering community banks get the
capital to make room on their books for substantial
new loans? An innovative answer is provided by the
state of North Dakota, one of only two states (along
with Montana) expected to meet its budget in 2010.
North Dakota was also the only state to actually gain
jobs in 2009 while other states were losing them.
Since 2000, North Dakota’s GNP has grown 56 percent,
personal income has grown 43 percent and wages have
grown 34 percent. The state not only has no funding
problems, but in 2009 it had a budget surplus of $1.3
billion, the largest it ever had – not bad for a state
of only 700,000 people.
North Dakota is the only state in the union to own its
own bank. The Bank of North Dakota (BND) was
established by the state legislature in 1919
specifically to free farmers and small businessmen
from the clutches of out-of-state bankers and railroad
men. Its populist organizers originally conceived of
the bank as a credit union-like institution that would
provide an alternative to predatory lenders, but
conservative interests later took control and
suppressed these commercial lending functions. The BND
now chiefly acts as a central bank, with functions
similar to those of a branch of the Federal Reserve.
However, the BND differs from the Federal Reserve in
significant ways. The stock of the branches of the Fed
is 100% privately owned by banks. The BND is 100%
owned by the state, and it is required to operate in
the interest of the public. Its stated mission is to
deliver sound financial services that promote
agriculture, commerce and industry in North Dakota.
Although the BND is operated in the public interest,
it avoids rivalry with private banks by partnering
with them. Most lending is originated by a local bank.
The BND then comes in to participate in the loan,
share risk, buy down the interest rate and buy up
loans, thereby freeing up banks to lend more. One of
the BND's functions is to provide a secondary market
for real estate loans, which it buys from local banks.
Its residential loan portfolio is now $500 billion to
$600 billion. This function has helped the state avoid
the credit crisis that afflicted Wall Street when the
secondary market for loans collapsed in late 2007 and
helped it reduce its foreclosure rate. The secondary
market provided by the “shadow lenders” is provided in
North Dakota by the BND, something other state banks
could do for their community banks as well.
Other services the Bank provides include guarantees
for entrepreneurial startups and student loans, the
purchase of municipal bonds from public institutions,
and a well-funded disaster loan program. When North
Dakota failed to meet its state budget a few years
ago, the BND met the shortfall. The BND has an account
with the Federal Reserve Bank, but its deposits are
not insured by the FDIC. Rather, they are guaranteed
by the State of North Dakota itself - a prudent move
today, when the FDIC is verging on bankruptcy.
A New Vision for a New Decade
A state-owned bank has enormous advantages over
smaller private institutions: states own huge amounts
of capital (cash, investments, buildings, land, parks
and other infrastructure), and they can think farther
ahead than their quarterly profit statements, allowing
them to take long-term risks. Their asset bases are
not marred by oversized salaries and bonuses, they
have no shareholders expecting a sizable cut, and they
have not marred their books with bad derivatives bets,
unmarketable collateralized debt obligations and
mark-to-market accounting problems.
The BND is set up as a dba: "the State of North Dakota
doing business as the Bank of North Dakota."
Technically, that makes the capital of the state the
capital of the bank. The BND's return on equity is
about 25 percent. It pays a hefty dividend to the
state, projected at over $60 million in 2009. In the
last decade, the BND has turned back a third of a
billion dollars to the state's general fund,
offsetting taxes.
By law, the state and all its agencies must deposit
their funds in the bank, which pays a competitive
interest rate to the state treasurer. The bank also
accepts funds from other depositors. These copious
deposits can then be used to plow money back into the
state in the form of loans.
Although the BND operates mainly as a “bankers’ bank,”
other publicly-owned banks, including the Commonwealth
Bank of Australia, have successfully engaged in direct
commercial lending as well. This has proven to be a
win-win for both the borrowers and the government. The
public bank model also offers exciting possibilities
for refinancing the state’s own debts and funding
infrastructure nearly interest-free. For a fuller
discussion, see “Cut Wall Street Out! How States Can
Finance Their Own Recovery.”
For three centuries, the United States has thrived on
what Benjamin Franklin called “ready money” and today
we call “ready credit.” We can have that abundance
again, by generating our own credit through our own
state and local banks. Just as George Bailey needed a
visit from an angel to point the way, so we just need
the vision to see the possibilities.
Arianna’s vision for moving our money from the large
banks into our local community banks is a very
admirable first step. However, those community banks
are not likely to have sufficient capital to free up
credit for their local businesses and other customers
without the partnership of state-owned banks, or the
publicly-owned banks of counties and larger cities,
which also have ample capital assets. A number of
states, counties and cities are actively exploring
this option. The BND model shows us how
government-owned banks and community banks can work
together to get money flowing back to Main Street
again.
Ellen Brown developed her research skills as an
attorney practicing civil litigation in Los Angeles.
In Web of Debt, her latest book, she turns those
skills to an analysis of the Federal Reserve and “the
money trust.” She shows how this private cartel has
usurped the power to create money from the people
themselves, and how we the people can get it back. Her
earlier books focused on the pharmaceutical cartel
that gets its power from “the money trust.” Her eleven
books include Forbidden Medicine, Nature’s Pharmacy
(co-authored with Dr. Lynne Walker), and The Key to
Ultimate Health (co-authored with Dr. Richard Hansen).
Her websites are www.webofdebt.com and
www.ellenbrown.com.
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