North Dakota Tells Wall St. Not Only Game in Town

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Yves Smith: State-owned bank a model that publicly-owned banks can work

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PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay in Washington. President Obama delivered a State of the Union speech with very little discussion about finance regulation. I guess he thinks that’s done with the bill that was passed. But most people that have looked at that bill have said it did not deal with the big issue, which is too-big-to-fail banks. When you have banks that gamble and lose and create systemic risk, the state comes in and bails them out. And most commentators have said there’s very little in this bill that would stop this from happening again. So if you can’t pass a piece of legislation through Congress that will actually take on too-big-to-fail, what’s the alternative? Now joining us from New York City with a definite idea of what an alternative might look like is Yves Smith. She’s the author of the book ECONned and creator of the website NakedCapitalism.com. Thanks for joining us, Yves.

YVES SMITH, AUTHOR, BLOGGER: Paul, thanks so much. Glad to be here.

JAY: We’re really [inaudible] if I understand it correctly, we’re really not in a different moment in time: another big systemic collapse in the banking sector and the government’s likely to run back in again. What’s the alternative to private banks gambling and throwing the whole economy into risk?

SMITH: Well, there are alternatives that weren’t considered in any serious way in the financial reform regulation. You know, one is that the too-big-to-fail could have been confronted more frontally in terms of forcing banks to break themselves up at least into smaller pieces, some of which could be resolved. I mean, for example, there’s very serious discussion on right now in the UK of basically going to the model that we used to have, of Glass-Steagall, of having retail banks separated from the wholesale banking operations so at least even if a big bank, even if a big what we would call dealer bank, one of the banks that trade a lot, were to fail, it wouldn’t cost taxpayers as much money to rescue them, because they wouldn’t be attached to, you know, the big retail banking operation. But another option which was ignored was simply regulating the banks very heavily. You know, we had that model. It comported itself very well from the Depression through the later ’70s and ’80s when we began to start deregulating. And as soon as we started deregulating, we had a savings and loans crisis. A third alternative, which was–ironically, was indirectly put forward in the Obama administration, was the idea of finding ways to promote plain-vanilla products more aggressively. I mean, they had that as part of the–probably the most important part of the proposed consumer financial reforms was the idea that banks would be required to offer what they call plain-vanilla products, which would be a very simple mortgage, you know, a very simple credit card product. And that was one of the things the banks shot at the hardest, because complexity is their best friend. It enables them to hide all kinds of traps and snares, as Elizabeth Warren put it, in their products. Obviously there are other channels for getting those kind of products offered. I mean, for example, you know, credit unions and smaller community banks often offer simple products. But it’s possible for them to be disseminated through other channels. I mean, one of the models that people seldom think of is that there is such a thing as a state bank. There’s one state bank in the country. It’s the Bank of North Dakota. It actually takes–its deposits just come from tax receipts. So when you pay your state taxes or if you pay, say, business franchise taxes in North Dakota, instead of that deposit going to a private bank, it goes into the state bank. And the state bank of North Dakota has used it since 1919 in very productive ways to promote the state economy.

JAY: So, in other words, if public option made sense in the health-care sector, why not a public option in the finance sector?

SMITH: Exactly. And if the–you know, if there’s–you know, since it was defeated on a national level, you still have a lot of states where banking interests are not as powerful. You know, one of my–one of the banking experts I–you know, Chris Whalen sort of jokingly says that basically the further you get west of the Mississippi, the less friendly they are to banks. Now, California, with Wells Fargo being a headquarters, would be a big exception, but the point is that there are a lot of states where banking interests are not as powerful as they are in some of the states where banks are headquartered.

JAY: So the argument should be, then, to move the capital of the country somewhere near North Dakota.

SMITH: That would be one solution. Those Upper Midwesterners certainly did a good job of not participating in the financial crisis.

JAY: What’s the actual evidence of the success of the North Dakota model?

SMITH: Well, first, it made money in 2009 when almost all the banks in the country lost money. It returns half of its profits as dividends to the state, and that’s been about–over the last ten years it’s been a third of a trillion dollars. And that’s a state–remember, North Dakota has a very small population. It’s only got 600,000 people. So it’s actually provided a surplus on a very regular basis to the state and has served as a very productive channel for development. And also, occasionally, emergency funding. For example, there was a very big flood. You know, for North Dakota it would’ve been a Katrina-level flood. And the state bank was actually very quickly able to fund different kinds of rescue operations and rebuild operations in the wake of that disaster. But more often what they will do is they’ll partner with local banks. And a local bank may have a project or it may have some kind of lending that it wants to promote. And the state bank has the advantage, unlike these big national banks, that they actually know the community. I mean, it’s–you know, it’s–so it’s not as if they’re doing it by these score-based lending systems, where we saw so many of those blew up, where people believed the numbers and the numbers turned out to be too optimistic. They actually have a sense of who the players are, what makes sense.

JAY: During the last couple of years, when there’s been such a liquidity freeze across the country, was North Dakota able to avoid this?

SMITH: Yeah. Well, it was–and in fairness you can say that some of the success of the bank in dodging the bullet of the crisis was that North Dakota really didn’t participate in subprime to a significant degree. I mean, that was–you know, it was sort of a flyover state. All of the aggressive subprime lenders apparently didn’t think there were enough folks in farms that they could get to lever up to take on these dodgy loans. But the flip side is that the bank has also just been a very prudent lender. They’ve–you know, you read all over the country how all sorts of governments and municipalities participated in, you know, interest rate swaps that blew up on them. The state bank does no derivatives. They’ve been very conservative in the kind of things they get involved in. They say that they operate on the Warren Buffett rule: if we don’t understand it, we’re not going to do it.

JAY: And do they do loans? Do they–mortgages, small business loans, all of these? In other words, they compete with private banks?

SMITH: Well, they like to say that they go a very fine line between competing and cooperating. So it’s sort of an interesting dance, that they nudge the private sector, but then they also provide enough support to the private sector that it’s as much a–it’s mainly a cooperative relationship with some sort of nudging around the margins. I mean, for example, they provide different check–they’re sort of a mini-Fed. They provide check-clearing operations to different banks in the state. They provide overnight lending. You know, banks will often broker loans among themselves. They participate in the overnight lending, and that helps lower the cost of funding to the local banks. And similarly, as I said, they will partner with banks. So a bank will bring them a project, and so they will provide additional funding to the project. You know. And many times, again, for a small bank–might have a project it wants to do that is too large relative to what that bank would feel comfortable taking on, so they’ll sort of act as a wholesaler on loans. They won’t go out and originate the loan, but they have a staff that reviews the different proposals that come in from various local banks.

JAY: Now, the banks that they’re dealing with, are these, like, local representatives of the big national banking chains?

SMITH: Well, they’re in-state banks. So even if it was a representative, it would have to be strictly local, for strictly state purposes.

JAY: And in terms of a model, if for some reason the private banking sector was back in crisis again, is there any reason why that North Dakota publicly owned bank couldn’t directly loan money to the public?

SMITH: Well, in theory they could. In practice they didn’t. But in theory they–you know, if there was a–for example, a credit union or a smaller bank that somehow couldn’t get supported by the FDIC [Federal Deposit Insurance Corporation] that they thought could make it, conceivably they could bail it out. But that is a role another state bank could play. It is not a role that they played. Most of the smaller banks that got in trouble really got themselves in a lot of trouble and had to be wound down by the FDIC.

JAY: So the critique that would come from the sort of libertarian side, I guess, would be governments just don’t know how to run banks, and this will end up being something–you know, a boondoggle of one form or another. What’s the evidence about that?

SMITH: Well, the answer is: then explain how this bank has been around for 90 years and hasn’t gotten in trouble and has a record of being more profitable than private sector banks. I mean, the record of this bank doesn’t prove that. Now, you can argue that in other states there might be more pressure, particularly ones in big, you know, urban centers where there is–you know, there would be more budget pressures, that the bank would be pressured to do things that are risky. You’d have to be very careful that the bank had a conservative charter. But, you know, this bank shows that a bank can be run conservatively, prudently, make money, and have a cooperative, productive relationship with private sector banks.

JAY: So could this be reproduced nationally?

SMITH: You’d probably have to do it in states that were philosophically more conservative to begin with, where they would be willing to have a bank that was run on very conservative lines. So I would, again, anticipate that, you know, the fact that this–I think it’s no accident that this happened in a largely rural state.

JAY: Too-big-to-fail leads to structural blackmail, where Wall Street says to the rest of us, you let us fail, your entire economy is going into catastrophic meltdown, which is what we faced. So as an alternative to that, could there be some kind of public option that can say to Wall Street, you want to go gamble, you want to do derivatives and all this, okay, you’re going to go do it with your own money, but we’ll have an alternative way to have loans and liquidity in the economy that will be essentially done in the public interest.

SMITH: Well, a lot of economists actually propose that. There were several. Joe Stiglitz proposed that. A formal central banker, William Budd, proposed that. Believe me, this proposal has been floating around. This is one of these it would be nice if that would happen, it’s just not going to happen. You know, the very fact that the banks weren’t broken up and that there was no meaningful financial reform, it comes back to the same issue of political will [inaudible] political will to form a real competitor just in plain-vanilla products to the big banks, we would have been able to get–forcing them to offer plain-vanilla products through in the first place. They would’ve gone for that option had they thought that there was a realistic threat.

JAY: So maybe some form of the North Dakota model, state-by-state, starts to create–.

SMITH: That’s why I think it could potentially be important is that it would change the dynamic, that even if a few states took it on, it changes a perception that the private sector banks have a stranglehold, that this is the only way you can go, that it’s their way or the highway. I think it is actually much more important as a model to say to Wall Street, you don’t have to be the only game in town.

JAY: Thanks very much for joining us, Yves.

SMITH: Thank you.

JAY: And you can read more of Yves’ work at NakedCapitalism.com. And thank you for joining us on The Real News Network.

End of Transcript

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