Do State-owned Banks Violate State Constitutional Provisions? No.

–Prepared in consultation with Timothy Canova, Professor of Law, Chapman University, and Robert Bows, board of directors, Public Banking Institute; revised February 12, 2012 in consultation with Colorado attorney Earl Staelin.

The recent interest in state-owned banks has provoked challenges on grounds that they violate state constitutional prohibitions against lending the credit of the state.

The argument that a state-owned bank violates the constitutional prohibition against lending the credit of the state is not valid, for at least two reasons:

(1)  A number of states have owned banks historically, and many have infrastructure banks today, which are specifically authorized by 23 U.S. Code Section 610.  The constitutionality of state infrastructure banks does not seem to have been challenged; and the constitutionality of the state-owned Bank of North Dakota, which acts as a “bankers’ bank” and mini-Fed for the state, has been confirmed by the Supreme Court of North Dakota and the U.S. Supreme Court.

(2)  The argument misconstrues the nature of banking.  All states deposit their revenues and invest their capital in banks.  This does not mean they are “lending the state’s credit.”  The bank lends its own credit.  If the state can put its capital and revenues in a privately-owned bank, it can put them in a publicly-owned bank.

The Constitutional Language in Question Does Not Apply to Owning a Bank 

State constitutions typically have provisions forbidding the government to “give or lend the credit of the state.”  California’s constitution, for example, provides at Article 16 (Public Finance), Section 6:

The Legislature shall have no power to give or to lend, or to authorize the giving or lending, of the credit of the State, or of any county, city and county, city, township or other political corporation or subdivision of the State now existing, or that may be hereafter established, in aid of or to any person, association, or corporation, whether municipal or otherwise, or to pledge the credit thereof, in any manner whatever, for the payment of the liabilities of any individual, association, municipal or other corporation whatever . . . .

In the Washington State constitution, the prohibition is in Article VIII, Section 5 (a provision unchanged since 1889):

CREDIT NOT TO BE LOANED. The credit of the state shall not, in any manner be given or loaned to, or in aid of, any individual, association, company or corporation.

In the Colorado state constitution, Article XI, Section 1 prohibits the state from pledging its “credit or faith thereof” in favor of “any person, company, or corporation, public or private.”  Article XI, Section 3, prohibits the state from contracting “any debt by loan in any form.” The Constitution of North Dakota has similar provisions:

 ARTICLE X: FINANCE AND PUBLIC DEBT

Section 18. The state, any county or city may make internal improvements and may engage in any industry, enterprise or business, not prohibited by article XX of the constitution, but neither the state nor any political subdivision thereof shall otherwise loan or give its credit or make donations to or in aid of any individual, association or corporation except for reasonable support of the poor, nor subscribe to or become the owner of capital stock in any association or corporation. [Section 185 of 1918 constitution; emphasis added.]

North Dakota has had a state-owned bank since 1919, along with a state-owned granary.  In 1920, the legislation that enabled the Bank of North Dakota was challenged by a consortium of Minneapolis banks on behalf of 42 North Dakota taxpayers on grounds that it violated state constitutional provisions and the due process clause of the Fourteenth Amendment to the U.S. Constitution.  In  Green v. Frazier, 253 U. S. 233 (1920), the U.S. Supreme Court rejected this challenge.  It held

that legislation which provides for engaging the state in the businesses of manufacturing and marketing farm products, and of providing homes for the people, and which appropriates money, creates a state banking system, and authorizes bond issues and taxation for carrying the scheme into effect is not unconstitutional as respects taxpayers Page 253 U. S. 242.

The Court noted that the constitutionality of the legislation had been sustained by the Supreme Court of North Dakota.  The decision of the North Dakota Supreme Court (Green v. Frazier, 176 N.W. 11 (N.D. 1920); aff’d 253 U. S. 233 (1920), was therefore conclusive, so far as it rested on state grounds.

The only question left for the U.S. Supreme Court was the attack under the Fourteenth Amendment, alleging a deprivation of the plaintiffs’ right to property (their taxes) without due process of law.  The U.S. Supreme Court observed:

This legislation was adopted under the broad power of the state to enact laws raising by taxation such sums as are deemed necessary to promote purposes essential to the general welfare of its people. . . . (253 U.S. at 238)

[T]he Supreme Court of North Dakota held . . . concerning what may in general terms be denominated the “banking legislation,” that it was justified for the purpose of providing banking facilities . . . . (253 U.S. at 240)

As to the Home Building Act, that was sustained because of the promotion of the general welfare in providing homes for the people, a large proportion of whom were tenants moving from place to place. It was believed and affirmed by the Supreme Court of North Dakota that the opportunity to secure and maintain homes would promote the general welfare, and that the provisions of the statutes to enable this feature of the system to become effective would redound to the general benefit.  (253 U.S. at 242)

The decision of the Supreme Court of North Dakota upholding the legislation under the 14th Amendment was therefore affirmed.  The Bank of North Dakota (BND) has operated successfully ever since, serving largely as a “banker’s bank” within the state.

Many States Already Own Banks

Objection will be raised that state constitutions vary.  The fact that a state-owned bank is constitutional in North Dakota does not mean it is constitutional in other states.  That is true, but the issue has not even been raised in other states—states which have owned or now own their own banks.  Prohibitions against “lending the credit of the state” are vague at best, but it seems evident that they were not meant to apply to owning banks.

While North Dakota is the only state to own a BND-style “central” bank today, a number of states have owned them historically; and more than half the states now own infrastructure banks.  A July 2011 release by the Council of State Governments observed:

More than 30 states and Puerto Rico have created a state infrastructure bank, a type of revolving infrastructure investment fund that can offer loans and credit assistance to public and private sponsors of certain highway construction, transit or rail projects. Five states–Florida, Georgia, Kansas, Ohio and Virginia–have established banks or accounts within their banks that are capitalized solely with state funds.

If state funds can be used to capitalize a state infrastructure bank without violating state constitutional provisions, they can be used to capitalize a BND-style state-owned bank without violating those provisions.

Banks Advance Their Own Credit, Not the Credit of Their Depositors

The contention that a state-owned bank would “lend the credit of the state” misconstrues the nature of banking.  Banks do not actually lend the deposits of their depositors.  If they did, the state would not be able to deposit its revenues in Bank of America or Chase Bank without violating state constitutional provisions.  As the Federal Reserve Bank of Dallas explains on its website:

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.

As Michael Sauvante explains it on the website of the Commonwealth Group:

The number one privilege enjoyed by banks is their ability to create new money, in the form of credit granted to their borrowers. Banking laws permit a bank to create that credit based on the assets of the bank (generally defined by the Basel II Accord). This credit is not extracted from those assets (which remain untouched in the process), nor is it drawn from any other pool of money, but rather the assets serve strictly as the basis for calculating the total amount of new money that the bank is allowed to issue in the form of credit. That amount (usually a multiple of the assets, typically in the range of 10-12 times the value of the assets) is governed by regulators, and varies from bank to bank.

A state-owned bank would not lend the state’s credit but would accept the state’s revenues as deposits, just as Bank of America does now.  The state’s revenues would simply be shifted from one deposit account to another.

Some small portion of its capital would also be shifted from one investment to another.  Some idle rainy day fund, for example, might be used.  This would be an investment in equity, not an expenditure.  It would not cost the state money but rather would make money for the state.  The Bank of North Dakota has reported a return on equity in recent years ranging from 19% to 26%.

This is also true for the state’s deposits: they would not be spent or lent but would remain at all times deposited in the bank.

The state-owned bank would then do what all banks do: leverage this capital into credit backed by deposits.  And because the bank would be publicly owned and would have a mandate to serve the public, it could be expected, like the BND, to advance this credit conservatively for creditworthy local projects and needs.  Banking “would become boring again.”

In North Dakota (population 647,000), the Bank of North Dakota has $2.7 billion in deposits, or $4000 per capita; and virtually all of these deposits are drawn from the state’s own revenues.  The bank has nearly the same sum ($2.6 billion) in outstanding loans.

California has 37 million people.  On the same scale, California might amass $148 billion in deposits.  Assuming an 8% capital requirement, with $12 billion in capital, this $148 billion in deposits could generate $133 billion in credit for the state (subtracting 10%, or 14.8 billion, to satisfy reserve requirements).

If that credit were used, for example, to purchase $133 billion in municipal bonds paying 5% interest, the state would have made nearly $7 billion annually on its investment.  This is new revenue for the state, acquired without spending a penny more in taxes.

If it is constitutional for the Bank of America to make this income by leveraging the state’s capital and deposits for the benefit of the bank’s investors, it is constitutional for a state-owned bank to do it for the benefit of the state and its people.

 

36 Responses

  1. Breaking up central banks is as natural as packs of wolves and pods of whales breaking up when they get too big. Same thing happens to a bee hive. When it gets too big it naturally splits. This process is more akin to free enterprise whereas the other is more like capitalism. Free enterprise is the competition between communities and capitalism is the competition between individuals.

  2. Interesting piece Ellen. I’m curious, what can be used as tier 1 capital? If the state is the bank then all of the State of California’s assets (the real estate value alone…), on the other hand if the bank is a separate entity then the state will have to appropriate funds to capitalize it.

    Once the capital is taken care, like Mark Helprin would say, it all runs together like a song. There’s no need for the state to deposit its funds into the bank (though it’d be crazy to pay fees to a private bank for what it could do it itself) since each loan creates new reserves that are deposited in the bank. Even if the funds shift to another bank, the state could borrow the necessary reserves at the Fed Funds rate (0.08% yesterday). So the key figure is capital, the reserves will take care of themselves.

    And of course going forward there’s no reason for the state to issue new bonds, that’s just paying Wall Street its vig. The state could loan itself and municipalities money directly at any interest rate it chooses (personally I’d steer clear of direct loans to private parties, the potential for “public-private graft” would be enormous)– the reduced interest income would be matched dollar for dollar in reduced income expenditures. A few years ago Dennis Kucinich and (Republican) Steve LaTourette sponsored a federal bill to provide 0-interest infrastructure loans to states that could be used as a model for state banks. Heck, considering the Kucinich-LaTourette plan would fund hundreds of billions in infrastructure spending at no federal budgetary cost (unlike the President’s public-private graft infrastructure bank plan), its astonishing the Obama administration hasn’t pushed it— oh wait, Wall Street doesn’t get its vig here either, never mind.
    http://www.opencongress.org/bill/110-h3400/text

  3. Good news for the folks in San Francisco who are working on moving the city funds out of the big banks and then starting a city owned bank.

  4. The Supreme Court of North Dakota seems to have had a wish to promote the general welfare of its people and the state. What a contrast with some Courts in other states, and most of all the Supreme Court in Washington.
    If we had a Bank of California, it could solve the money problems and bring its economy forward. Jobs and infrastructure, even single payer healthcare could be possible.
    And it would be constitutional and “leverage the public’s money for the state of California and its people.”

  5. Above they call it “creating money” but it can also be called printing more money than they have backing or fractional reserve banking. Before the banks printed more “notes” for gold than they had gold, now they print on records or computers more money than they have federal reserve notes. It is still fraudulent and makes the banks vulnerable to runs.

    • I do think Ellen’s state banking model is excellent (she cites Tim Canova above, he’s the sharpest monetary law scholar anywhere), I’m surprised no other state or city has followed North Dakota’s lead, I hope San Francisco does take the leading oar on this.
      At the federal level, the blogger “RSJ” has written about a couple different ways Congress could pursue bank reform.
      http://windyanabasis.wordpress.com/2011/03/28/leaving-modern-money-theory-on-the-table/

      RSJ’s Option 1, ban the rents: Set up a Govt bank that would accept deposits from the public and would lend to banks at the policy interest rate it sets (vs present system of the Fed setting policy rate with Fed Funds rate), or Option 2, tax the rents away: Levy an adjustable bank asset tax to set policy rate. Here again RSJ suggest a “public option” bank (vs Option 1’s “single payer” bank) to take deposits.
      I’ll note that, since earlier year, the FDIC has levied a de facto bank asset tax with its insurance assessments (instead of its old “deposit tax”. Option 2 could be set in motion by the FDIC hijacking policy rate governance from the Federal Reserve, which as this AEI paper fumes, they sort of already have (“the FDIC has now injected itself in the monetary policy setting process”), when it started levying a bank asset tax, its cost was added on top of FFR. As a result, “The federal funds rate has declined from 14-18 basis points to 7 to 9 basis points”.
      http://www.aei.org/paper/economics/financial-services/the-fdic-and-unintended-consequences-of-dodd-frank/

      If the FDIC went further down that route, Congress could order FDIC assessment revenue rebated to Tsy– its on the hook for losses anyway– and bring back the old Postal Savings System (now with debit cards!). I suppose if Congress made it financially attractive for states to set up their own ND-style state banks (in lieu of depositing state funds in either Postal or private banks), every state would quickly jump on Ellen’s bandwagon. The Tsy Dept could (with a change in the law) spend electronic US Notes it creates, with the FDIC (whether still independent or at direction of Tsy Sec) setting the policy rate by adjusting its asset tax. Higher interest rates would bring in more revenue for Tsy (vs present system where higher rates mean higher debt service costs). Instead of paying $200 billion this year in net interest, Tsy would have received, say, a $200 billion FDIC rebate (and that $400B revenue swing would repeat year after year). If states were encouraged (aka “bribed”) to set up their own banks, they too would be free of the bond market and could provide their citizens improved govt services at a lower tax burden.

  6. Another proposition – a “monetary democracy” – http://bit.ly/tGdcWP

  7. Dear Ellen,

    I might need your help.

    The Commonwealth Bank of Australia has asked for input from customers and I have begun, i.e. to try to remind the Bank of the principles on which it was established.

    Currently I am in the process of posting a link to this particular topic, but when I make my proper submission, I want to be better armed.

    You and I first got acquainted – well sorta – when I read of you citing the Commonwealth Bank as being akin to the bank of N Dakota; but I had to tell you that the CBA had been partly privatized … but it is now putting out feelers.

    I will do what I can to remind the CBA of its origins, but I might need some assistance (any chance you might come to Australia – not serious).

    Meanwhile I am looking into the status of the Reserve Bank of Australia.

    It appears that it is little like the Fed in the US, e.g. it is not privately owned by other banks and still remains a branch of government that is allowed separate opinions … like the Bank of England under Mervyn King:

    http://investmentwatchblog.com/mervyn-kings-apology-i-sympathise-completely-with-savers-and-those-who-behaved-prudently-now-find-themselves-among-the-biggest-losers-from-this-crisis/

    These are worth a look, as a contrast with the Bernank and the bought Congress.

  8. […] the article here. GA_googleAddAttr("AdOpt", "1"); GA_googleAddAttr("Origin", "other"); […]

  9. […] Do State-owned Banks Violate State Constitutional Provisions? No. (webofdebt.wordpress.com) […]

  10. […] should be looked at, are local publicly owned and/or non-profit financial institutions, of which, there exists a long and proven economic and Constitutional track record. "North Dakota has had a state-owned bank since 1919, along with a state-owned granary. The […]

  11. In a way Ellen and her many banking articles are pushing me to figure out our banking system. Lincoln was murdered by the Banksters’ because Lincoln directed the government to print money, greenbacks. JFK murdered for the same reason. So whatever entity prints the money controls the banking system. The Banksters, the individuals who own our FED, murder any individual who threatens to take their printing money privilege from them. Banking is banking. State banks, the Bank of North Dakota makes money but its second to the entity who prints the money, the FED. Unless the government prints the money, and we must get rid of the private corporation known as the FED for this to take place, the problem still exists even if each state has its own bank, I think. This comment is really me thinking out loud.

  12. Some great information on here and some great comments. Makes for interesting reading. Thank you for sharing this article.

  13. […] Do State-owned Banks Violate State Constitutional Provisions? No. Demand Tax Fairness in WA! […]

  14. […] Th&#1077 U.S. Supreme Court, h&#959w&#1077&#957&#1077r, h&#1072&#1109 ruled t&#959 th&#1077 contrary. In 1920, th&#1077 constitutional objection w&#1072&#1109 raised &#1110n conjunction w&#1110th th&#1077 Bank &#959f North Dakota &#1072nd w&#1072&#1109 rejected both b&#1091 th&#1077 Supreme Court &#959f North Dakota &#1072nd th&#1077 U.S. Supreme Court. See Green v. Frazier, 253 U. S. 233 (1920), &#1072nd fuller discussion here. […]

  15. […] The U.S. Supreme Court, however, has held otherwise. In 1920, the constitutional objection was raised in conjunction with the Bank of North Dakota and was rejected both by the Supreme Court of North Dakota and the U.S. Supreme Court. See Green v. Frazier, 253 U. S. 233 (1920), and fuller discussion here. […]

  16. […] in the Debate!The Way to Occupy a Bank Is to Own One | Local Philadelphia News Aggregator on Do State-owned Banks Violate State Constitutional Provisions? No.Some Body (@KevinOnEarth) on Pulling Back the Curtain on the Wall Street Money MachinePulling […]

  17. […] and the U.S. Supreme Court.  SeeGreen v. Frazier, 253 U. S. 233 (1920), and fuller discussionhere.        JUSTALUCKYFOOL ASKS A SIMPLE QUESTION,”THE FEDERAL RESERVE BANK OF […]

  18. […] The U.S. Supreme Court, however, has held otherwise. In 1920, the constitutional objection was raised in conjunction with the Bank of North Dakota and was rejected both by the Supreme Court of North Dakota and the U.S. Supreme Court. See Green v. Frazier, 253 U. S. 233 (1920), and fuller discussion here. […]

  19. […] and the U.S. Supreme Court.  See Green v. Frazier, 253 U. S. 233 (1920), and fuller discussion here.    […]

  20. […] The U.S. Supreme Court, however, has held otherwise. In 1920, the constitutional objection was raised in conjunction with the Bank of North Dakota and was rejected both by the Supreme Court of North Dakota and the U.S. Supreme Court. See Green v. Frazier, 253 U. S. 233 (1920), and fuller discussion here. […]

  21. […] The Portland Press Herald, December 3, 2011. 5. See GREEN V. FRAZIER, 253 U. S. 233 (1920). 6. Do State-owned Banks Violate State Constitutional Provisions? No., The Web of Debt Blog, December 2, […]

  22. […] The U.S. Supreme Court, however, has held otherwise. In 1920, the constitutional objection was raised in conjunction with the Bank of North Dakota and was rejected both by the Supreme Court of North Dakota and the U.S. Supreme Court.  See Green v. Frazier, 253 U. S. 233 (1920) , and fuller discussion here. […]

  23. […] The U.S. Supreme Court, however, has ruled to the contrary. In 1920, the constitutional objection was raised in conjunction with the Bank of North Dakota and was rejected both by the Supreme Court of North Dakota and the U.S. Supreme Court. See Green v. Frazier, 253 U. S. 233 (1920), and fuller discussion here. […]

  24. […] The U.S. Supreme Court, however, has held otherwise.  In 1920, the constitutional objection was raised in conjunction with the Bank of North Dakota and was rejected both by the Supreme Court of North Dakota and the U.S. Supreme Court.  See Green v. Frazier, 253 U. S. 233 (1920), and fuller discussion here. […]

  25. […] The U.S. Supreme Court, however, has held otherwise. In 1920, the constitutional objection was raised in conjunction with the Bank of North Dakota and was rejected both by the Supreme Court of North Dakota and the U.S. Supreme Court. See Green v. Frazier, 253 U. S. 233 (1920), and fuller discussion here. […]

  26. […] The U.S. Supreme Court, however, has held otherwise. In 1920, the constitutional objection was raised in conjunction with the Bank of North Dakota and was rejected both by the Supreme Court of North Dakota and the U.S. Supreme Court. See Green v. Frazier, 253 U. S. 233 (1920), and fuller discussion here. […]

  27. […] No obstante, la Corte Suprema de Justicia de los Estados Unidos, ha sostenido lo contrario. En 1920, la objeción constitucional se planteó en conjunto con el Banco de Dakota del Norte y fue rechazada tanto por el Tribunal Supremo de Dakota del Norte como por la Corte Suprema de los Estados Unidos. Ver Green v. Frazier, 253 U.S. 233 (1920), y un análisis más completo aquí. […]

  28. […] dalla Corte Suprema degli Stati Uniti. Vedi la vertenza Green-Frazier del 1920 e un’ampia analisi qui.Una banca comunale farebbe con fondi pubblici soltanto quello che sta facendo in questo momento […]

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