Vermont Citizens Push to Form a State Bank, But Will Ratings Agencies Kill the Idea?

Martha R wrote to tell me that a serious effort is underway in Vermont to launch a state bank. 20 towns will be voting on town meeting resolutions to establish a home-grown, public bank. The objective is not to set up a retail bank (say along the lines of a Post Office bank) but to save the fees that are now paid to large financial institutions and to fund public projects. She writes:

Town meetings cannot make it happen but they serve as a litmus test of existing political will and they send a message to state government that is heeded. There’s already a bill in the state senate.

As readers may know, the one state bank in existence, that of North Dakota, has been a success. As we wrote in 2011:

The Bank of North Dakota has an enviable track record, having remained profitable during the credit crisis. Moreover, in the ten years prior, the bank returned roughly half its profits, or roughly a third of a billion dollars, to the state government. That is a substantial amount in a state with only 600,000 people. The bank was also able to pay a special dividend to the state the last time it was on the verge of having a budget deficit, during the dot-bomb era, thus keeping state finances in the black.

But the good financial performance is simply an important side benefit. The bank’s real raison d’etre is to assist the local economy. And it has done so for a very long time. It was established in 1919 as part of a multi-pronged effort by farmers to wield more power against entrenched interests in the East.

And the most important potential use of this type of bank in our era could again be to level the playing field with powerful interests, in this case, the TBTF banks.

The Bank of North Dakota serves as a repository for state taxes and fees. It does not originate loans but will chose to participate in loans that local banks bring to it. It also acts as a mini-central bank and provides overnight funding to in-state banks.

The idea for the Vermont bank is a tad more ambitious, since it would build on an existing, well-run non-profit public agency that provides loans, the Vermont Economic Development Authority. The state Senate bill proposes having VEDA obtain a banking license and take 10% of state deposits. Supporters hope that as the state bank gains experience, it would eventually hold all state funds, which are mainly now with TD Bank.

An article in Vermont Public Radio describes the issues raised against it. One of the nay-sayers is the state Treasurer, Beth Pearce, argues that a state bank would not be efficient. Vermont’s cash balances range from $20 million to $300 million over the course of a year. However, I’m not convinced. Every study of bank efficiency has found that banks show increasing cost curves (as in their costs rise as total assets grow) with the break point occurring as low as around $1 billion to as high as $25 billion (ironically, I’ve had difficulty finding any studies since the early 2000s, no doubt because the finding were contrary to the myth that bigger banks are more efficient). And a state bank would not have a costly branch network or individual account/transaction processing, which means it would be efficient at a lower level of activity than a conventional bank.

The biggest potential fly in the ointment is that the ratings agencies may take a dim view of a state bank. As the article explains:

She [Pearce] says if Vermont’s relatively small cash assets were in a state bank that money would be at greater risk; for example if loans go bad.

And if the big credit rating agencies see a public bank as risky, it jeopardizes Vermont’s bond rating.

Pearce says that’s important because a lower bond rating makes it more expensive for the state and lending agencies to borrow money.

A poor bond rating “turns around and affects every Vermonter.” Pearce says. “Whether it’s affordable housing, whether it’s a college education for students, commercial development in the state, commercial energy improvements in the state. Those are the types of things that benefit from our bond rating. I don’t want to put that at risk.”

Public bank supporters say the risk is overstated. They point to VEDA’s success and its high loan repayment record. Gary Flomenhoft [author of a study on state banking] argues that state money in large institutions like TD Bank is also at risk.

Unfortunately, the risk that the ratings agencies will take a dim view is real, because they often act as enforcers for major financial players. As Matt Stoller wrote in 2011:

In the early 2000s, several states attempted to rein in an increasingly obvious predatory mortgage lending wave. These laws, pushed by consumer advocates, would have threatened the highly profitable mortgage securitization pipeline.

S&P used its power to destroy this threat. Josh Rosner and Gretchen Morgenson told the story in Reckless Endangerment.

Standard & Poor’s was the most aggressive of the three agencies, however. And on January 16, 2003, four days after the Georgia General Assembly convened, it dropped a bombshell. Because of the state’s new Fair Lending Act, S&P said that it would no longer allow mortgage loans originated in Georgia to be placed in mortgage securities that it rated. Moody’s and Fitch soon followed with similar warnings.

It was a critical blow. S&P’s move meant Georgia lenders would have no access to the securitization money machine; they would either have to keep the loans they made on their own books, or sell them one by one to other institutions. In turn, they made it clear to the public that there would be fewer mortgages funded, dashing “the dream” of homeownership.

Can you see the topsy-turvy reasoning? Because Georgia proposed to hold lenders and investors in securitizations accountable for predatory loans, S&P said these higher-quality loans were ineligible to be included in mortgage pools. Why? Because, in the presumably smaller percentage that did wind up being predatory anyhow, the state could seek recourse from lenders. That arguably might lower cash flows to investors. Can’t have investors be responsible for their decisions, now can we?

And S&P’s press release made clear it intended to kill any similar rules in other states:

It ended with a warning: “Standard & Poor’s will continue to monitor this and other pending predatory lending legislation.” In other words, any states that might have been considering strengthening their predatory lending laws as Georgia did should beware.

That press release is here. S&P was aggressively killing mortgage servicing regulation and rules to prevent fraudulent or predatory mortgage lending.

The third risk, which overlaps with the second, is that of geographic concentration. But I’d hazard the bigger real risk is cronyism. North Dakota is the one survivor of seven state banks that were established. The fundamental reason it performed well and the others didn’t was the others were subject to greater and lesser degrees of corruption. By contrast, the North Dakota state bank prides itself on its conservatism. The good track record of the VEDA and the high degree of civic engagement in Vermont says the bank has decent odds of escaping this pitfall.

But will the state risk incurring the wrath of the rating agency hit men? Stay tuned…..

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  1. President Costanza

    Excellent article on an issue the msm won’t cover. The truth is that a state bank in Vermont would likely succeed; Vermont politics don’t suffer from persistent corruption like NJ, NY, LA, and many other states.

    Also, I suspect there is one other reason that the powerful interests don’t want a state bank in Vermont. The state bank in North Dakota doesn’t pay the huge salaries that the big banks pay. The conventional Wall St./beltway wisdom is that you need huge salaries to attract “talent”, but the Bank of North Dakota shows that is not the case (BND didn’t receive any TARP funds, while many of the big banks did). The CW crowd (which includes the rating agencies) certainly doesn’t want another state owned bank showing that huge salaries are unnecessary.

    1. Dan Kervick

      Right. Obviously big finance sees public banking as the camel’s nose under the tent, the same way big health sees public options for health care. Once the public realizes that public agencies can, in many cases, deliver exactly the same financial products and services as the private sector but at far less cost, the whole private financial plutocracy is at risk.

      1. just me

        I don’t want exactly the same financial products, I want honest, safe, healthy ones — BIG diff.

        This post makes me think of two of the segments in Capitalism: A Love Story, Michael Moore’s documentary. One was on the state bank of North Dakota (in the DVD bonus features?). And I also remember his interview with Elizabeth Warren where she said we don’t allow manufacturers to sell us toasters that blow up, yet we allow banks to sell us financial products that blow up — mortgages, credit cards, loans.

        Come on, Vermont!

  2. allcoppedout

    We had a nice little ethical bank here, the Cooperative. Turns out it was running at a loss and has now dragged the whole Cooperative group down. Some really weird old duffers seem to have been in charge. In Northern Ireland even credit unions have been run into the ground by crooks. We should be sending cops in rather than auditors.

    BND sounds good and, of course, many conservative banks, building societies and credit unions once formed much of our utility banking around Europe and the US. I’d like to see world banking taken over by BND clones, but I do wonder how many small institutions of this sort were bent.

    I suspect we need rid of the rating agencies and big audit firms’ influence to form a new money and finance utility. We need to remember that even something as profoundly sensible-sounding as micro finance has been a general disaster. The main issue is how to return money to honesty. My two main axe grinding areas concern modularising the economy and removing poverty wages and stealing from sensible future provision (pensions etc.) as a means of making profit.

    1. diptherio

      The fiasco with the Cooperative Bank in the UK displays some of the problems that I think are inherent in large bureaucratic orgs, even co-op ones. The larger the institution grows, the more difficult it becomes to exert democratic control over and the easier it becomes for upper-level employees to game the org, just like execs do with private companies.

      This is one of the issues that the Solidarity Economy/New Economy movement needs to address–the problems and promise of scale–how to build the movement, without losing control of our enterprises.

      Cooperators Confront the “System Problem ~GEO News

      1. allcoppedout

        I go with all that Diptherio. The gaming scams are usually very simple, a bit like me always beating you at chess and the strange phenomenon of you always finding yourself in a much worse position after toilet breaks. I have to say organising self-management is very tough and organising fraud all-too-easy. My guess is we have to find a system to maintain and improve quality without the abusive ‘motivational profits’ for a few. At the same time we need people to ‘jump’ when asked and not go on holiday at crucial times.

  3. F. Beard

    Government backing for credit creation or government credit creation itself for private parties violates Equal Protection Under the Law, especiallly in favor of the rich since they are deemed more so-called “creditworthy.” Instead, banks should be 100% private with 100% voluntary depositors.

    Besides, if we were returned the Equity stolen from the population via the government-backed credit cartel then:
    1) Fewer people would need to borrow in the first place.
    2) More people would have cash to honestly lend.

    Which reminds me, I’ve got to see that film “Noah” to remind me that justice is coming with or without Progressives.

      1. F. Beard

        The Equal Protection Clause is part of the Fourteenth Amendment to the United States Constitution. The clause, which took effect in 1868, provides that no state shall deny to any person within its jurisdiction the equal protection of the laws.

        A primary motivation for this clause was to validate and perpetuate the equality provisions contained in the Civil Rights Act of 1866, which guaranteed that all people would have rights equal to those of white citizens. As a whole, the Fourteenth Amendment marked a large shift in American constitutionalism, by applying substantially more constitutional restrictions against the states than had applied before the Civil War.

        The meaning of the Equal Protection Clause has been the subject of much debate, and the well-known phrase “Equal Justice Under Law” has become an abbreviated form of the constitutional provision. This provision was the basis for Brown v. Board of Education (1954), the Supreme Court decision that helped to dismantle racial segregation, and also the basis for many other decisions rejecting discrimination against people belonging to various groups. from [bold]

        Government backing/enabling of the banks allow them to bypass the savings (loanable funds theory) of the poor and other less so-called creditworthy (and thus the need to pay honest real interest rates) and to directly create new purchasing power, not for the general welfare, but for the private interests of the so-called creditworthy.

        As for the Gospel:

        He has told you, O man, what is good; and what does the Lord require of you but to do justice, to love kindness, and to walk humbly with your God? Micah 6:8 [bold added]

  4. nowhere

    Can someone explain to me exactly how the ratings agencies have managed to retain even a shred of credibility in anyone’s eyes?

    1. BillC

      Maybe it’s not credibility, but mutual back-scratching, just like the BoD/CEO upward compensation spiral run by essentially the same self-interested crowd? If the “serious people” who run banks, mutual funds, etc. that manage Other Peoples’ Money pretend to regard the ratings agencies as credible, then the ratings agencies’ opinions will cover their a**es when the results of their poor investments come home to roost. Everybody involved has a strong interest in maintaining the facade. Even though a child can easily recognize the overwhelming conflict of interest in the ratings agencies’ business model, who else’s opinion would make a difference (other than a financial regulator who believes in their mission, a thoroughly extinct species)?

      1. Carla

        Oh, maybe you put your finger on the problem: the customary response to criminal activity has become to stop paying attention to it.

        I can see that this is greatly to the advantage of the criminals, but not so great for the rest of us.

        Yves–I hope you are feeling much better.

  5. F. Beard

    Why not have the monetarily sovereign US Federal Government make 0% loans to the States? If those loans promote the general welfare? Why the heck are governments paying ANY interest to the private sector?

  6. okie farmer

    The bill in the Senate designates Vermont Economic Development Authority as the vehicle around which to build a state bank. I’m suspicious of that tactic, because in most states ECD is used to subsidize rich corporations and wealthy “investors”. VEDA may be an up-and-up outfit, as this piece maintains, but if the bill gets through the legislature and signed into law, there will be every manner of pols and special interests not only trying to subvert it, but determined to make it a crony capitalist outfit. I realize Vermont is ‘different’ from the rest of US, somewhat as ND is different. But if the bill goes through I think there’s more risk from VEDA being corrupted than the rating agencies trying to take it down.

    1. Jim Haygood

      Seems like a basic prudential step to separate a public bank from an economic development authority. That way the bank can vet proposed EDA loans and compare them to its other lending opportunities.

      1. susan the other

        I guess combining a state retirement fund with a state bank would not be prudent either, although I can see that as a very, very socially beneficial and useful partnership. As far as S&P blackmail goes, I hope Vermont does not cower too much. They could come up with the Vermont Home Ownership Plan which could take the idea of a mortgage to a new and enlightened level. Or is current mortgage procedure cast in stone?

  7. j gibbs

    The Fed has ended any suggestion that large banks are in any sense responsible. Big banks are simply looting engines. They drain the resources of the many, pump up asset prices by fueling speculation, engorge executives as they become progressively insolvent, and tap the federal treasury to cover their tracks.

    How could a State bank be any worse? Well, it could make bad loans to political cronies and undermine the State’s credit, making borrowing more costly.

    What we really need is smaller, geographically limited, soundly regulated private banks, with small depositors protected, bondholders and shareholders exposed to true risk, and executives honestly compensated for actual work making actual loans rather than market bets. Anyone as old as I am remembers when we had such banks. A series of finaglers starting with Walter Wriston and David Rockefeller, and continuing with Bob Rubin and Bill Clinton, succeeded in screwing everything up and putting the looters in charge of a Fed backstopped casino.

    Do I want a bunch of elected politicians running a bank in their spare time? In fifty years of looking, I haven’t noticed a handful of politicians capable of running an outdoor toilet in their full time. It just shows how desperate we have become to see intelligent, responsible people recommending such a thing.

    1. F. Beard

      If government-backed credit creation could be done responsibly then why are we still waiting after 320 years? Besides, no one is (credit)worthy of legally stolen goods.

      Btw, the Lord will give a society centuries (e.g. the Ammorites) to repent before destroying it if it does not. We should not mistake patience for non-existence or weakness:

      And He was also saying to the crowds, “When you see a cloud rising in the west, immediately you say, ‘A shower is coming,’ and so it turns out. And when you see a south wind blowing, you say, ‘It will be a hot day,’ and it turns out that way. You hypocrites! You know how to analyze the appearance of the earth and the sky, but why do you not analyze this present time?

      “And why do you not even on your own initiative judge what is right? For while you are going with your opponent to appear before the magistrate, on your way there make an effort to settle with him, so that he may not drag you before the judge, and the judge turn you over to the officer, and the officer throw you into prison. I say to you, you will not get out of there until you have paid the very last cent.” Luke 12:54-59 New American Standard Bible (NASB)

      1. j gibbs

        FB, the crimes which have been committed by history’s Bible thumpers dwarf anything even imagined by today’s bankers. Why do you suppose that is?

        1. F. Beard

          Z the crimes which have been committed by history’s Bible thumpers dwarf anything even imagined by today’s bankers. j gibbs

          Really? The Great Depression (caused by the banking cartel) was a major cause of WWII which killed 50-65 million people. I doubt even the Bible-abusing Roman Catholic Church killed that many including the Crusades.

          Why do you suppose that is? j gibbs

          Such killing as has been done in the name of Christ has been done contrary to His will:

          John answered and said, “Master, we saw someone casting out demons in Your name; and we tried to prevent him because he does not follow along with us.” But Jesus said to him, “Do not hinder him; for he who is not against you is for you.”

          When the days were approaching for His ascension, He was determined to go to Jerusalem; and He sent messengers on ahead of Him, and they went and entered a village of the Samaritans to make arrangements for Him. But they did not receive Him, because He was traveling toward Jerusalem. When His disciples James and John saw this, they said, “Lord, do You want us to command fire to come down from heaven and consume them?” But He turned and rebuked them, [and said, “You do not know what kind of spirit you are of; for the Son of Man did not come to destroy men’s lives, but to save them.”] And they went on to another village. Luke 9:49-56 New American Standard Bible (NASB)

          The Bible cannot be held to account because of the crimes of people who do not understand it because, for one thing, hastiness is condemned by the Bible itself:

          Do you see a man who is hasty in his words? There is more hope for a fool than for him. Proverbs 29:20

          For another, the Bible is nuanced so that, for example, killing a man during a war is justified but killing that same man during a peace or truce is murder. See 1 Kings 2:5-6 for David’s condemation* of his own nephew, Joab, his military commander, because “he also shed the blood of war in peace.”

          Please, for your own safety Progressives (and to avoid embarassing yourself), know that Book you hate or despise. It’s survival is not in question; YOURS is and you have blood on your hands to the extent you support government-backed banking.

          1. F. Beard

            *David himself did not execute Joab perhaps because of Joab’s loyality to David (which included murdering Uriah the Hittite, the husband of Bathsheba, to cover David’s adultery with her) but he made it very plain to his succesor, his son Solomon, what his desire was: So act according to your wisdom, and do not let his gray hair go down to Sheol in peace. 1 Kings 2:6

  8. Katniss Everdeen

    “Pearce says that’s important because a lower bond rating makes it more expensive for the state and lending agencies to borrow money.”

    I was under the impression that a state bank would “create” the money that state agencies and municipalities borrow using the same fractional reserve lending laws that all banks use. The cost of borrowing would be set at the state level, not in New York on Wall Street, and that cost would be returned to the state as “profit.”

    Under those circumstances, why would it matter WHAT ratings agencies did? Why would they even be asked to weigh in?

    As for lack of access to securitization–keeping loans ON THE BOOKS instead of discounting, tranching and selling to “investors”–that’s what banks USED to do. Back when they were “boring” but safe.

    It would seem that a state bank would free Ms. Pearce from the tyranny of “bond ratings” not subject her to it. And tying the amount of money the state can borrow to its deposits–the amount available for repayment–sounds like a pretty solid way to do business.

    1. susan the other

      Keeping your own mortgage contracts on your own books can actually be a plus in a well-run financial universe, albeit it a small universe. All those mortgages should actually be “assets” and not disastrous liabilities.

    2. j gibbs

      Why would it matter what the rating agencies did? Because the State always needs to borrow in the bond market. It doesn’t do pay as you go financing. Those tax revenues service the bonds and (hopefully) cover operating expenses. That’s all.

      1. Katniss Everdeen

        But “banks” can lend a multiple of their deposits–10x??? That’s what fractional reserve banking/ lending is, and it’s the basis for money “creation” by banks such as Chase.

        So, with deposits of $300 million, a state bank could lend $3 billion. No?? They don’t need Chase to create money from nothing, they do it themselves.

        With a state bank, the state doesn’t need to access JP Morgan’s “bond market,” it lends to itself with money that it created. Isn’t that the point of this whole thing?

    3. Yves Smith Post author

      States do not create money. The US (fiat currency issuer) can but not a state government. States borrow from investors in the bond market.

      If rating agencies downgraded Vermont because it didn’t like the existence of a state bank (“it will take too many risks, could leave the state with losses and hence impair the state’s ability to meet its other obligations”) it WOULD raise the cost of selling new bonds.

  9. Eclair

    Colorado also has a citizens’ group, Colorado Public Banking, led by Robert Bows, that is advocating for a State Bank. They are now working to place an amendment on the Colorado ballot.

  10. bob

    Who is behind the push? I can’t find much reporting on it beyond the VPR story, which cites an insurance vet and a VC (condo seller) as opponents.

    AIG is very big in VT. Will this be their new “bank”?

    I don’t think that VT has the state level “power” to do it, honestly.

  11. Minor Heretic

    A Vermonter here.

    I’m all for it. Not only a VEDA based bank, but a state credit union with all the trimmings.

    One of our state senators pointed out that the people of the little state of Vermont pay out $250 million annually in credit card interest, mostly to out of state banks. Then we turn around and write separate checks for taxes to the state. Why not pay that $250 million to the state bank and enrich our own public coffers? That would be 6% of our annual budget. It could be our financial equivalent to the public option in health care.

    Or, better yet, cut out the predatory penalty rates and fees, take in less money, and give Vermonters better financial situations.

    If the ratings agencies screw up our credit then I guess we’ll have to go from 10% to 100% self sufficient sooner than expected. Maybe we can cooperate with North Dakota.

    We’ll also have single payer health care (in 2017), the highest number of artisanal breweries, bakeries, and cheese makers per capita, the overall healthiest population, and the highest cooperative membership. And we provide a great place for same-sex couples to get married.

    Vermont: America’s wake-up call.

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