According to Ambrose Evans-Pritchard, writing last month in the UK Telegraph, U.S. bank credit and M3 (the broadest measure of the money supply) contracted over the summer at rates comparable to the onset of the Great Depression. In the summer quarter, U.S. bank loans fell at an annual pace of almost 14 percent. "There has been nothing like this in the USA since the 1930s," said Professor Tim Congdon of International Monetary Research. "The rapid destruction of money balances is madness."
Chartered banks are allowed to create credit on their books equal to many times their deposit base, but lately they haven't been doing it. In more normal times, one dollar in base money has been fanned by the banks into $8.50 in loans. Today, one dollar in base money is producing only one dollar in loans. Although the Fed has been frantically pushing cash into the banks, it can't make them lendto consumers.
This is not because the banks are trying to be difficult. If they had prudent loans on which to turn a profit and the capital base to do it, they no doubt would. But their books have been choked with toxic assets, destroying their capital positions; and the "shadow lenders" who once took subprime loans off their books have gotten wise to the scam and gone away. Bankers who know the endangered state of their own books don't trust each other, so money is tight all around. And the Fed has already dropped interest rates as low as they can go, so it has no more leverage with which to entice borrowers.
Local Government to the Rescue?
The Fed may have played all its cards, but state and local governments still hold a few aces. Some local politicians are looking into the feasibility of opening their own publicly-owned banks, providing them with their own credit machines. A new public bank would have a clean set of books, untainted by the Wall Street addiction to gambling in complex derivatives; and its profits would go back to the local government and community, rather than being siphoned off in exorbitant salaries, bonuses and dividends. A publicly-owned bank could funnel credit where it is needed most, directly into the local economy.
One legislator who is considering a publicly-owned bank is Bruno Barreiro, County Commissioner for Miami-Dade County in Florida. In a September 23 article titled "Capital Sources: Recession Steers Banks Away from Business as Usual", The Daily Business Review reported that Miami-Dade is planning to conduct a feasibility study proposing alternatives for becoming its own depository. Said the journal:
"Barreiro notes that throughout the year, a portion of the county's $7.5 billion operating budget is deposited with outside financial institutions in return for an interest rate. However, he feels that given the instability of many banks, the county might be better off going into such a business on its own."
Brian Bandell, writing in The South Florida Business Journal on September 11, reported that Barreiro's concern is that bank accounts are insured by the FDIC for only up to $250,000. Some businesses have lost millions of dollars in uninsured deposits when banks failed. The county often has over $50 million in a single account. If the county were to open its own depository institution, it could safeguard against these losses.
However, said Bandell, Barreiro is not proposing to allow the institution to make loans. Rather, the state's money would be invested conservatively in Treasury bonds. The problem with that approach, said Miami banking analyst Kenneth Thomas, is that it would be a challenge to get good interest rates for the county's deposits without making loans. "There's a reason most other municipalities aren't doing it," he said.
In stopping short of making loans, the county could be missing a major business opportunity. The average interest rate on U.S. government bonds is currently 3.35%. If the funds in Miami-Dade's operating budget were deposited in the county's own bank, the money could serve as the reserves to support at least nine times that sum in loans. Assuming an average interest rate of 5% on these loans, the county could increase its revenues by over 1,000% (45% vs. 3.35%). [A fuller explanation and references are here.]
Maximizing the Potential of a Publicly-owned Bank