– The Chicago Federal Reserve, Modern Money Mechanics (last updated 1992)
Not only are banks merely pretending to have the money they lend to us, but today they are shamelessly demanding that we bail them out of their own imprudent gambling debts so they can continue to lend us money they don’t have. According to the Comptroller of the Currency, the books of U.S. banks now carry over $180 trillion in a form of speculative wager known as derivatives. Particularly at issue today are betting arrangements called credit default swaps (CDS), which have been sold by banks as insurance against loan defaults. The problem is that CDS are just private bets, and there is no insurance commissioner insuring that the “protection sellers” have the money to pay the “protection buyers” if they lose. As loans have gone into default, the elaborate gambling scheme built on them has teetered near collapse, threatening to take the banking system down with it. Now the players are demanding that the government underwrite their bets with taxpayer funds, on the theory that if the banking system collapses the public will have no credit and no money. That is the theory, but it misconstrues the nature of money and credit. If a private bank can create money simply by writing credit into a deposit account, so can the federal government. The Constitution says “Congress shall have the power to coin money,” and that is all it says about who has the power to create money. It does not say Congress can delegate to private banks the right to create 97% of the national money supply in the form of loans. Nothing backs our money except “the full faith and credit of the United States.” The government could and should have its own system of public banks with the authority to issue the credit of the nation directly.
Buyouts, not Bailouts
Accumulating a network of publicly-owned banks would be a simple matter today. As banks became insolvent, instead of trying to bail them out, the government could just put them into bankruptcy and take them over. Insolvent banks are dealt with by the FDIC, which is authorized to proceed in one of three ways. It can order a payout, in which the bank is liquidated and ceases to exist. It can arrange for a purchase and assumption, in which another bank buys the failed bank and assumes its liabilities. Or it can take the bridge bank option, in which the FDIC replaces the board of directors and provides the capital to get it running again in exchange for an equity stake in the bank. An “equity stake” means an ownership interest: the bank’s stock becomes the property of the government.2 Nationalization is an option routinely pursued in Europe for bankrupt banks. As William Engdahl observed in a September 30 article, citing economist Nouriel Roubini for authority:
“[I]n almost every case of recent banking crises in which emergency action was needed to save the financial system, the most economical (to taxpayers) method was to have the Government, as in Sweden or Finland in the early 1990’s, nationalize the troubled banks [and] take over their management and assets . . . . In the Swedish case, the Government held the assets, mostly real estate, for several years until the economy again improved at which point they could sell them onto the market . . . . In the Swedish case the end cost to taxpayers was estimated to have been almost nil. The state never did as Paulson proposed, to buy the toxic waste of the banks, leaving them to get off free from their follies of securitization and speculation abuses.” 3
As in any corporate acquisition, business in the banks nationalized by the government could carry on as before. Not much would need to change beyond the names on the stock certificates. The banks would just be under new management. They could advance loans as accounting entries, just as they do now. The difference would be that interest on advances of credit, rather than going into private vaults for private profit, would go into the coffers of the government. The “full faith and credit of the United States” would become an asset of the United States. Instead of paying half a trillion dollars annually in interest, the U.S. could be receiving interest on its credit, replacing or eliminating the need to tax its citizens.
Three Ways to Fund the New New Deal
There are three ways government could fund itself without either going into debt to private lenders or taxing the people: (1) the federal government could set up its own federally-owned lending facility; (2) the states could set up state-owned lending facilities; or (3) the federal government could issue currency directly, to be spent into the economy on public projects. Viable precedent exists for each of these alternatives:
1. The Federal Bank Option
The federal government could issue credit through its own lending facility, leveraging “reserves” into many times their face value in loans just as banks do now. Franklin Roosevelt funded his New Deal through the Reconstruction Finance Corporation (RFC), a government-owned lending institution. However, the RFC borrowed the money before lending it.4 A debt-free alternative would be for a government-owned bank to issue the money simply as “credit,” without having to borrow it first. This was done by the state-owned central banks of Australia and New Zealand in the 1930s, allowing them to avoid the worldwide depression of that era.5 In the informative booklet “Modern Money Mechanics,” the Chicago Federal Reserve confirms that under the fractional reserve system in use today, one dollar in reserves is routinely fanned by private banks into ten dollars in new loans.6 Following that accepted protocol, the government could fan the $700 billion already earmarked to unfreeze credit markets into $7 trillion in low-interest loans.
Apparently, that is how Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke are planning to generate the $7 trillion they say they are now prepared to advance to rescue the financial system: they will just leverage the $700 billion bailout money through the banking system into $7 trillion in new loans.7 But the Federal Reserve is a privately-owned banking corporation, and the recipients of its largesse have not been revealed.8 The $700 billion in seed money belongs to the taxpayers. The taxpayers should be getting the benefit of it, not a propped-up private banking system that uses taxpayer money for the “reserves” to create ten times that sum in “credit” that is then lent back to the taxpayers at interest.
Seven trillion dollars in government-issued credit could furnish all the money needed to fund Obama’s New Deal with a few trillion to spare. Among other worthy recipients of this low-interest credit would be state and local governments. Many state and municipal governments are going bankrupt just because interest rates shot up when the monoline insurers lost their triple-A ratings gambling in the derivatives market.9
2. The State Bank Option
While states are waiting for the federal government to step in, they could charter their own state-owned banks that issued low-interest credit on the fractional reserve model. Article I, Section 10, of the Constitution says that states shall not “emit bills of credit,” something that has been interpreted to mean they cannot issue their own paper currency; but there is no rule against a state owning or chartering a bank that issues ten times its deposit base in loans, using standard fractional reserve principles.
Precedent for this approach is found in the Bank of North Dakota (BND), the nation’s only state-owned bank. BND was formed in 1919 to encourage and promote agriculture, commerce and industry in North Dakota. Its primary deposit base is the State of North Dakota, and state law requires that all state funds and funds of state institutions be deposited with the bank. The bank’s earnings belong to the state, and their use is at the discretion of the state legislature. As an agent of the state, BND can make subsidized loans to spur economic and agricultural development, and it is more lenient than other banks in pressing foreclosures. Under a program called Ag PACE (Agriculture Partnership in Assisting Community Expansion), the interest on loans made by BND and local lenders may be reduced to as low as 1 percent.10 North Dakota remains fiscally sound at a time when other state governments swim in red ink, and its educational system is particularly strong. While disruptions in capital markets have hampered student loan operations elsewhere, BND continues to operate a robust student loan business and is one of the nation’s leading banks in the number of student loans issued.11 North Dakota’s fiscal track record is particularly impressive considering that its economy consists largely of isolated farms in an inhospitable climate. Ready low-interest credit from its own state-owned bank may help explain this unusual success.
3. Government-issued Currency
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