Official Congressional budget estimates understate the peril of rising debt, Fed chair Ben Bernanke told the Budget Committee on Capitol Hill today.Warning that our nations fiscal health has deteriorated appreciably since the onset of the financial crisis and the recession, Bernanke called upon lawmakers to confront the long term fiscal challenges sooner rather than later. If lawmakers dont confront them, theyll find themselves confronted by them.From Bernankes prepared remarks:By definition, the unsustainable trajectories of deficits and debt that the CBO outlines cannot actually happen, because creditors would never be willing to lend to a government with debt, relative to national income, that is rising without limit. One way or the other, fiscal adjustments sufficient to stabilize the federal budget must occur at some point. The question is whether these adjustments will take place through a careful and deliberative process that weighs priorities and gives people adequate time to adjust to changes in government programs or tax policies, or whether the needed fiscal adjustments will come as a rapid and painful response to a looming or actual fiscal crisis.Bernanke explained that the Congressional Budget Offices calculations miss an important reality. As the governments debt and deficits rise, the economy will slow down—an effect not taken into account by the CBO. So, for instance, when the CBO says that federal spending for health-care programs will roughly double as a percentage of GDP in the next 25 years, it is probably being too optimistic. If debt keeps, rising, GDP will be much lower than the CBO estimates—which will mean that health care spending will be a much larger percentage of the overall economy.Heres Bernanke on the effect of rising debt:Sustained high rates of government borrowing would both drain funds away from private investment and increase our debt to foreigners, with adverse long-run effects on U.S. output, incomes, and standards of living. Moreover, diminishing investor confidence that deficits will be brought under control would ultimately lead to sharply rising interest rates on government debt and, potentially, to broader financial turmoil. In a vicious circle, high and rising interest rates would cause debt-service payments on the federal debt to grow even faster, resulting in further increases in the debt-to-GDP ratio and making fiscal adjustment all the more difficult.
Archive for the ‘Future of Banking’ Category
“THIS brutal lack of confidence” is how the chief executive of one of Europe’s biggest banks describes the situation facing his firm and its peers. The catalogue of troubles afflicting the institution (call it Bank X, so as not to punish it for its candour) shows how worrying the outlook has become for big banks, and hence for the real economy.
A bank-funding crisis that started on Europe’s periphery with worries over Greek, Irish and Spanish banks has now infected the core of the West’s financial system. The governments of France and Belgium said this week they would stand behind the debts of Dexia, a perennially troubled lender, while also engineering a break-up of the bank. Across the Atlantic shares in American banks whipsawed on worries about a Greek default and rumours of policy breakthroughs.
For Bank X, the most pressing issue is a freezing of funding markets as investors ponder the potential impact of losses that banks may take on their holdings of euro-zone government bonds. American money-market funds have almost completely withdrawn dollar funding from European banks over the past few months. This is forcing them to sell dollar assets. Some of these transactions will do no harm to the sellers: there are buyers at reasonable prices. But Bank X is also cutting traditional banking activities denominated in dollars. Some of these include critical functions such as trade finance.
A bigger worry is a freeze in euro funding. Institutional bondholders such as pension funds and insurers have refused to buy unsecured European bank debt in any meaningful quantities since early summer, and balk entirely at durations longer than two years. “There are a lot of banks that would be willing to give away assets if they could, just so they don’t have to fund them,” says one investment banker. Bank X is trimming euro assets, accelerating plans to cut the size of its balance-sheet. Other lenders are doing the same. That risks driving down asset prices, forcing lots of banks to mark down equivalent assets and erode capital. Deleveraging also means a reduction in lending activity.
Equity investors are running scared. The shares of European banks have fallen by 40% over the past three months.
Money in a government-owned bank could give us the best of both worlds. We could have all the credit-generating advantages of private banks, without the baggage cluttering up the books of the Wall Street giants, including bad derivatives bets, unmarketable collateralized debt obligations, mark to market accounting issues, oversized CEO salaries and bonuses, and shareholders expecting a sizeable cut of the profits. A state could deposit its vast revenues in its own state-owned bank and proceed to fan them into eight to 10 times their face value in loans. Not only would it have its own credit machine, but it would control the loan terms. The state could lend at ½% interest to itself and to municipal governments, rolling the loans over as needed until the revenues had been generated to pay them off. According to Professor Margrit Kennedy in her 1995 book Interest and Inflation-free Money, interest composes, on average, fully half the cost of every public project. Cutting costs by 50% could make currently-unsustainable projects such as low-cost housing, alternative energy development, and infrastructure construction not only sustainable but actually profitable for the government.If all this seems too radical and unprecedented to venture into, consider that one state has had its own bank for 90 years; and it has not only escaped the credit crunch but is doing remarkably well…The Innovative Bank of North DakotaOnly three of 50 states are now solvent, meaning they have the revenues to meet their state budgets; and one of them is North Dakota. It is an unlikely candidate for the distinction. It is a sparsely populated state of fewer than 700,000 people, largely located in isolated farming communities afflicted with cold weather. Yet since 2000, the states GNP has grown 56%, personal income has grown 43%, and wages have grown 34%. The state not only has no funding issues, but this year it actually has a budget surplus of $1.2 billion, the largest it has ever had.
Cut spending, raise taxes, sell off public assets – these are the unsatisfactory solutions being debated across the nation; but the budget crises now being suffered by nearly all the states did not arise from too much spending or too little taxation. They arose from a credit freeze on Wall Street. In the wake of the 2009 financial market collapse, banks curtailed their lending more sharply than in any year since 1942, driving massive unemployment and causing local tax revenues to plummet.
The logical solution, then, is to restore credit to the local economy. But how? The Federal Reserve could provide the capital and liquidity necessary to create bank credit, in the same way that it provided $12.3 trillion in liquidity and short-term loans to the large money center banks. But Fed Chairman Ben Bernanke declared in January 2011 that the Fed had no intention of doing that — not because it would be too costly (the total deficit of all the states comes to less than 2% of the credit advanced for the bank bailout) but because it is not part of the Fed’s mandate. If Congress wants the Fed to advance credit to local governments, he said, it will have to change the law.
The states are on their own. Policymakers are therefore considering a variety of reforms designed to increase bank lending, particularly to small businesses, the hardest hit by tightening credit standards. One measure that is drawing increasing interest is the creation of a bank modeled on the Bank of North Dakota (BND), currently the only state-owned bank in the country. The BND has a 92-year history of safe, secure and highly profitable banking. North Dakota has the lowest unemployment rate in the country; and in 2009, when other states were floundering, it had the largest budget surplus it had ever had.
Eight states now have bills pending either to form state-owned banks or to do feasibility studies to determine their potential. This year, bills were introduced in the Oregon State legislature on January 11; in Washington State on January 13; in Massachusetts on January 20 (following a 2010 bill that lapsed); and in the Maryland legislature on February 4. They join Illinois, Virginia, Hawaii, and Louisiana, which introduced similar bills in 2010. The Center for State Innovation, based in Madison, Wisconsin, was commissioned to do detailed analyses for Washington and Oregon. Their conclusion was that state-owned banks in those states would have a substantial positive impact on employment, new lending, and state and local government revenue.
State-owned banks could be a win-win for everyone interested in a thriving local economy. Objections are usually based on misconceptions or a lack of information.
As states struggle to meet their budgets, public pensions are on the chopping block, but they needn’t be. States can keep their pension funds intact while leveraging them into many times their worth in loans, just as Wall Street banks do. They can do this by forming their own public banks, following the lead of North Dakota—a state that currently has a budget surplus.