Last week, the Federal Reserve Bank of Boston (FRBB) released a report titled “The Bank of North Dakota: A Model for Massachusetts and Other States?” The report confirms that the Bank of North Dakota (BND) is a prudent, well-managed financial institution that serves in partnership with community banks as an effective economic backstop to credit contractions. The report also shows how the BND has evolved over the years to use its asset base to increasingly inject liquidity into its economy while maintaining conservative lending practices.
The report suggests, however, that forming a state-owned bank is probably not worth the effort in Massachusetts. We respectfully disagree. Below is the response of the Public Banking Institute to the report’s bulleted conclusions:
- BND’s most important role in 2011 is serving as a lending partner for North Dakota’s numerous small banks.
While conceding that the BND provides significant financial advantages (improved capitalization ratios and increased profitability) to community banks, the FRBB report suggests that this function is less important for other states, including Massachusetts, since they have “bankers’ banks” serving in that capacity, and they have many large banking institutions in their larger cities that can take on complex lending projects.
While it may be true that large Wall Street-based banks are available to take on complex local lending projects, the fact is that they are not doing this adequately. They are reported to be more interested in using today’s extremely low Fed Funds rate to speculate, invest abroad, or invest in risk-free government bonds, profiting from the spread. Moreover, they are leveraging the states’ revenues and assets for these investments. State-owned banks could recapture this spread for their own local needs.
Out-of-state money center banks are now dominating the banking business in our major cities, squeezing out local banks that would be interested in undertaking complex local projects if they had the capital and other resources to do it. A state-owned bank can provide those resources, just as the BND does for local banks in North Dakota.
As for the private bankers’ banks in the state, we quote from an earlier response by the Center for State Innovation:
“Quarterly aggregated financial data compiled by the Bankers’ Bank Council estimates that bankers’ banks provide services to 58% of the banks in their respective markets. But this leaves a little over 40% of the banking market not being served by the very small number of bankers banks out there. Also, the bankers’ bank market is dominated by one bank: about 30% of the market (in terms of deposits and assets) is controlled by TIB: The Independent Bankers Bank, headquartered in Texas [obviously not a Massachusetts bank]. . . .
“Public institutions compete productively with private ones in a multitude of sectors: education, energy, mail service, student lending, library services. The Federal Reserve system provides services that private bankers’ banks might also provide, but most agree that its existence is indispensible for the banking sector.
“North Dakota is an excellent example: it has both a large, healthy, and long-running state bank and a private bankers’ bank operating in the state’s credit market. The Minnesota-based United Bankers’ Bank works with community banks in North Dakota and is even a member of the North Dakota Bankers Association – who incidentally are very supportive of the Bank of North Dakota. And even though United Bankers’ Bank and the Bank of North Dakota have some overlapping services, this does not mean that there isn’t enough business for both banks. In fact over the last 7 years, United Bankers’ Bank has more than doubled its assets and deposit base and now has over $640 million in assets and $440 million in deposits.”
- The willingness and capacity of a state-owned bank to offset a serious credit crunch has not been shown.
Figure 8, page 13, of the FRBB report shows that North Dakota escaped the credit crisis with the lowest foreclosure rate in the country. This is not due to some property unique to North Dakota real estate, since the same chart shows a large spike in foreclosures in the state in the 1980s. What changed? Figure 2, page 8, shows that in the 1980s, the BND was investing in securities and cash equivalents rather than in loans. The foreclosure rate went down in direct correlation to the shift in the BND’s investment strategy away from securities into loans. We believe this data clearly demonstrates the positive effect BND has had in offsetting the recent credit crunch.
- With the possible exception of the Great Depression, BND’s contributions to stabilizing the state economy and finances appear to have been relatively minor.
Again we disagree. A stable banking sector is essential to the health and stability of a state’s economy, and the BND has clearly contributed to the health and diversity of North Dakota’s banking sector. The state of North Dakota has the highest number of banks per capita of any state, and there have been no bank failures in the state in over 11 years, unlike in the rest of the USA, which has seen hundreds of bank failures just in the last 3 years.
- The potential costs of starting up a state-owned bank could be significant.
The FRBB’s method of calculating these costs (at p. 19) is dubious at best. The report takes the BND’s $2 million capitalization in 1919, multiplies by 12.5 “adjusting for inflation,” then multiplies by another 13 adjusting for “growth,” to come up with a figure of $325 million. Then it scales up again for the size of the Massachusetts economy to arrive at $3.6 billion as the amount of capital needed to start a bank. This looks like serious double-counting. Moreover, there are much more accurate ways of determining capitalization requirements for a modern bank than looking at banking requirements in 1919.
Capitalization needs vary, depending on how large the legislature wants the bank to be. A bank today could be started with as little as $20 million. The bank can start small and grow. Moreover, its capital base needn’t come from the budget or from tax revenues. “Capital” is an equity investment, not an expenditure. It can come from existing rainy day funds and other investment funds sitting idle, or from a bond issue.
- Massachusetts and other states should start any discussions of financial-sector reforms by identifying the problems that public policy needs to address.
This is obviously a good idea, but in a number of places the FRBB report goes on to proffer as its preferred solution “adopting policies that complement current federal lending programs.” The Federal Reserve is the entity charged with overseeing many of those programs, so this proposed solution would be expected. However, it is submitted that the federal lending programs have largely failed to achieve their goals.
Fed Chairman Ben Bernanke has stated that the easy-money credit facilities made available to the too-big-to-fail banks cannot be made available to state and local governments; and funds provided by the federal government will soon be terminated. As noted in a report by the Massachusetts Budget and Policy Center:
“During the current fiscal crisis, the state has . . . relied on over $1.5 billion a year in Recovery Act and related funding from the federal government. These federal funds played an important role in helping states protect critical services and avoid additional tax increases during the recession, yet those funds will be gone in FY 2012. Economists have cautioned that this termination of federal efforts to protect and create jobs – while the economy remains weak – will likely slow our economic recovery.”
The Bank of Massachusetts proposed in HO 1192 can help with those funding needs. By partnering with local banks to provide the credit and liquidity required for a healthy economy, and by supplying significant non-tax revenue for the state, the proposed Bank of Massachusetts can be a significant engine for economic growth in the state.