A Revolution in Banking and Economics
State Banking- A Real
California Solution
to the Debt and Jobs Crises
Wall Street has failed us. After being bailed out at great expense by the government and its taxpayers, the nation’s largest private banks have drastically cut back on the traditional types of loans counted on by local economies. These big banks are not facilitating an economic recovery and have actually become obstacles to it. They are dead-weight being carried by the taxpayers.
Today as in the 1930’s, Wall Street, private investors, and big banks have not stepped up to lead recovery efforts. During the Great Depression, it was instead the federally owned Reconstruction Finance Corporation (RFC) that was instrumental in galvanizing private investment to create real economic growth. Circumstances today demand another RFC type of solution which reformers across the country believe will help restore American prosperity through a resurgence in the industrial and manufacturing sectors of the economy.
To create credit, a bank needs capital and deposits. The money already exists in the states to create sufficient amounts of credit. State and local governments do not have to wait on the federal government to act. They can create their own RFC’s, using the trillions of dollars in deposits and pension funds which belongs to them and is currently sitting idle. California has long been a trendsetter among states in terms of legislation and public policy. Presently, it may be in the best position of any state to take the lead nationally on this issue.
California Can break the Bank
Many bills are pending in the legislature which will give the state greater authority to invest public funds for job creation and economic development. Little known is that California already has a fully functional state owned bank called the Infrastructure and Economic Development Bank, or I-bank.
California is on track to be the first state in the US to follow North Dakota in setting up a robust state banking system. The I-bank seems to be doing a fine job for Californians, but it is not adequately capitalized to carry out its mission nor does it have the authority to take on the enormous task of turning the tide of recession toward recovery.
The California Public Employees’ Retirement System (CalPERS) has over $239.2 billion in assets and California State Teachers Retirement System (CalSTRS) has a $150 billion fund. Increasing the capital of the I-bank and forming a state investment trust with just a portion of these two funds could be sufficient to make the state economically independent. That would enable them to adequately invest in their own economic recovery and support job creation programs that reach down to the city and county levels. An action like this would shift the balance of power and put California in a position of greater strength when doing business with Wall Street and private financial markets.
Building State Banks on a Solid Foundation
There are two uniquely American models of State Banking which California legislators can rely on to form an investment trust and expand its existing I-Bank. The first is the Bank of North Dakota and the second is the federally sponsored Reconstruction Finance Corporation which existed in the 1930′s and 40’s.
During the Great Depression the RFC returned a profit to the US treasury of $500 million dollars on a principal of $10.5 billion through its economic recovery loans. Like any other for profit business, the RFC paid for its own operating expenses. The Bank of North Dakota (BND) similarly operates on a for profit basis and has returned hundreds of millions of dollars in profits to the North Dakota treasury. BND is in large part responsible for the state being insulated from the effects of the present financial crises. Among other amazing facts about North Dakota are that it has budget surpluses, no general obligation debt, the lowest unemployment rate of any state in the US, and no significant bank failures in the state over the last decade.
One common operational feature of both the RFC and the BND is the emphasis on making participation loans and providing banking services to small and medium sized banks. Like the RFC, the BND has independence and flexibility to fulfill its economic mission. Both have operated with a conservative business approach to lending, seeking to augment private bank lending rather than be in competition with it. Loan programs are set up in which the state bank provides part of the financing in partnership with private banks. In practice, all of the application screening and collection of loan payments falls to the private banks, which obligate themselves to repay the state bank its portion of the loan. This process creates a buffer between the state bank and the loan applicant. The private bank buffer also serves as a form of check and balance, and reduces the need for bureaucracy and operational overhead at the state bank.
The North Dakota Public Finance Authority (NDPFA) helps all political subdivisions within the state access financing in private markets at the most favorable rates possible. NDPFA has loan programs for Capital Financing, School Districts, Industrial development, and emergency credit for natural disasters. Although not formally required to do so, the RFC performed a similar role in helping states and cities get the best interest rates for their bonds in the private markets.
The RFC also acted as the primary agent for selling bonds on the open market on behalf of the Public Works Administration. The PWA engaged in national infrastructure and construction projects, and with the help of the RFC made a substantial profit on its bond issues. In total the RFC purchased PWA securities having a par value of $694,739,787.58 and took full responsibility for any losses while returning all profits back to the PWA.
In 1932 Congress gave the RFC the responsibility of distributing $300,000,000 in relief funds to the states. This amount of money was expanded by New Deal policies so that between 1933 and 1937 the RFC distributed another $2 billion dollars in relief to government agencies in order to counter the effects of the depression. The RFC had no discretion to allocate this particular money, and simply disbursed it as specified by Congress. However, there were some unused funds in the program which the RFC decided to invest in ways which provided relief to states and cities.
Disaster Loans
In partnership with the BND, the North Dakota Department of Emergency Services has a Disaster Relief Program which makes prompt loans to affected municipalities, businesses, and individuals. During the 1997 Red River flood, the BND provided disaster loans and applied a moratorium on certain loan repayments to BND from flood victims. According to former BND official Ed Sather, the State of North Dakota suffered no losses from those BND activities.
The RFC likewise had a disaster loan program. As part of its fight against the Great Depression the RFC created and operated the Disaster Loan Corporation which made over 24,900 individual loans to sufferers of natural catastrophes. According to RFC Chairman Jesse H. Jones :
“Floods, droughts, freezes, hurricanes, explosions, and storms came in all sizes and in all manner of places. To one-mule farmers in the deep south, male and female, white and black, who needed just a little money to tide them over a severe dry spell, we made loans as small as $15.”
The RFC policy was to rely on committees of local individuals in affected areas to decide how much to lend each applicant. The committees did so according to what they knew a person’s means of repayment to be, and the RFC generally followed the loan recommendations of these local committees. The majority of these loans were repaid in full. Of the $54,000,000 lent through the Disaster Loan Corporation, only $2,135,000 was charged off, and these cases were generally because the borrowers died or lost their jobs.
The History of the RFC in California
The California Aqueduct and the Oakland Bay Bridge were just two of the many Depression era projects in California that were financed by the RFC. These super projects were made possible by “self-liquidating” loans. Such loans were authorized by Congress to create jobs in cases where the project had a revenue stream capable of paying off the construction loan. Thus stimulus was accomplished without new taxes or government spending. Examples of repayment options include tolls from bridges and fees for water or power generated from a dam, aqueduct, or water treatment plant. The California aqueduct made growth in southern California possible by bringing water over 244 miles from the Colorado River to Los Angeles, San Diego and other southern California communities. The Oakland Bay Bridge constructed in the 1930’s was a great success which made commuting and transportation more efficient in the San Francisco Bay Area.
The impact of the RFC investing in California reached far beyond infrastructure projects through its subsidiary companies such as Defense Supplies Corporation and Defense Plant Corporation. Many of California’s defense plants and other industries came into being with the help of these RFC funds during World War II. Among state recipients of RFC investment, California ranked #8. California companies received $323,206,000 out of a total of almost $8 billion invested nationwide Henry J. Kaiser, the West Coast shipbuilder and industrialist, had many dealings with the RFC and used $111 million of RFC money to build a steel plant in Fontana, California. The RFC also provided the initial money to Howard Hughes and Henry Kaiser to build the largest amphibious plane to have existed in the world, the H-4 Hercules, or “Spruce Goose,” formerly kept in Long Beach, CA.
BANK OF AMERICA GETS BOOST FROM RFC
After the stock market crash of 1929, California based Bank of America underwent a hostile takeover by New York banking interests. B of A’s founder A. P Giannini was eventually able to regain control of the board in the early 1930’s, at which time the RFC made them a loan that solidified Giannini’s position. Jesse Jones described how Mr. Giannini felt about the situation with Bank of America, “he believed that eastern financial interests, and later on some men highly placed in the Roosevelt administration, had designs on his institutions.”
It was through RFC loans that Bank of America was able to expand and become one of the nation’s largest banks. At the time it was perhaps the only large bank in the country which did not have headquarters in New York and wasn’t controlled by East Coast banking interests. In a letter to RFC Chairman Jesse H. Jones written on May 25th 1944, Mr. Giannini stated:
“I heartily agree with you that this is the only country where success comparable to that achieved by the Bank of America is possible, and I want you to know Jesse, that the stockholders, myself, and the management of the institution are very much indebted to you for having arrived where we are today. Had it not been for the faith you had in us in 1938 we would, I am quite confident, have found ourselves out of this picture and a part of some other institution in control of the very fellows who today are cornering most of the important business of the country.
“You have been a most loyal and true friend, Jesse, and I want you to know that Mario and I and the other members of our managing committee will ever bear in mind your having voluntarily undertaken to sponsor us at the time we were unjustly attacked by certain governmental agencies. “
The New Bay Bridge needs a New RFC
Presently, the Oakland Bay Bridge is in the process of being replaced, but by a different scheme than the RFC model used during the 1930’s. Concerns have been raised that today’s Bay Bridge project has been mismanaged by state bureaucracies. There have been large cost overruns and the primary contractor is outsourcing fabrication work to China where safety and quality issues have been eating up state resources. All factors combined appear to have added billions of dollars to the final price tag.
In contrast to today, the RFC provided project management, conducted contract negotiations, supplied engineering oversight, and fully financed the original bay bridge up front based on the security of revenue from future bridge tolls. Presently, institutions such as BATA- Bay Area Transit Authority, the Toll Bridge Program Oversight Committee (TBPOC), Cal Trans, and the California Infrastructure and Economic Development bank are all involved in replacing this same Bay Bridge but they seem to lack synergy, central leadership, efficiency, and sufficient capital to fully accomplish such a big undertaking. After two decades the project now appears to be heading in the right direction. But in the future such losses of time and money on similar projects might be avoided by using the RFC model to accomplish projects of this scale.
Another advantage to taxpayers and end users of bridge projects like this would be a for a RFC-style state bank entity to have firm control over all the construction debt. This would empower a public entity rather than private financial corporations to set rates for bridge tolls. Jesse Jones discussed how the RFC was involved in setting the toll prices for the original Bay Bridge:
“A condition of our loan was that the toll for private automobiles should be 65 cents, and the bridge authority would not reduce it without our permission as long as we held the bonds. It began earning so well that we soon allowed a toll reduction; first I think to 50 cents, then to 35. Today the toll is 25 cents, the bridge is making money, and the traffic is so thick that plans for a second bridge across the Bay are being evolved and its location debated.”
This historical example stands in sharp contrast to the price gouging that commonly takes place today whenever public works, utilities, and related services are privatized. To this day, California has not fully recovered from the damage that Enron and other private energy companies have done to its consumers, businesses, and taxpayers following the privatizing of its state energy sector.
RFC Fueled Economic Growth and Created New Industries
Those studying the creation of a California Investment Trust can learn much from the RFC and its pro-business policies. The RFC was exemplary of numerous successful partnerships with private investors. If not for the RFC, America would not have become the industrial and manufacturing giant it once was. In the words of Jones:
“The accelerated expansion of American Industrial Capacity during the second World War was of a magnitude without precedent in all the world’s economic evolution. Much of this great accomplishment was financed by the RFC through its subsidiary, Defense Plan Corporation at the request of the War and Navy Departments, the Office of Production Management, the War Production Board, the Maritime Commission, and occasionally other government agencies. They told us what they wanted built—and, usually where and by whom. We saw to it that the plants were constructed, equipped, and in most instances, competently operated. . . .
“To stimulate production of machine tools we made advances to manufacturers against purchase orders up to 30 per cent of the delivery price. These agreements, instituted the day after Pearl Harbor, were in effect underwritings. The Machine-tool commitments ultimately aggregated almost $2,000,000,000. They provided tool manufacturers with supplementary working capital.”
With a fully capitalized Infrastructure and Economic Development Bank program modeled on the programs of the BND and RFC, California could choose not to outsource billions of dollars in bridge fabrication projects to foreign countries or to other states. Such a decision would most likely entail the state playing a role in financing a bridge fabrication plant and related industries in the northern California region. A key consideration in such a decision is the fact that there are numerous bridges in the Pacific Northwest which are past due for repair or replacement. The California Bay Bridge Project raises significant questions about whether there is unmet market need for large bridge construction in the United States. This is occurring at a time when California is experiencing the highest unemployment rate since the Great Depression. If it is just a matter of financing new industrial facilities, why shouldn’t the jobs and spending for large bridge projects benefit the businesses and workers of California?
This type of economic development would also positively impact state revenues. The RFC history shows many examples of this kind of public financing initiative creating jobs and profits for the state, which in turn lightens the load on the taxpayer. According to RFC Chairman Jesse H. Jones:
“Defense Supplies sponsored industries new to America such as the making of jewel bearings, for which this country had previously been almost completely dependent upon the craftsmanship of the Swiss.”
Another example is the financing of a tin smelter in the United States. Jones stated:
“In their swift conquest of Holland, the Germans captured, among other valuable properties, the principal tin-smelting plant of the western world. One of the many worries in Washington at that moment was the fact that there were utterly no facilities in the United States for smelting tin. And this country was the world’s largest consumer of tin.
Today the Government of the United States owns the largest tin smelter on earth, thanks in large part to the push provided by two RFC subsidiaries, Metals Reserve Company and Defense Plant Corporation. The plant, known as the Longhorn smelter, is located at Texas City, on Galveston Bay. “
The RFC also sponsored the creation of what came to be the synthetic rubber industry in the United States. The RFC’s leading role in American industry used to be widely understood and respected among other nations of the world. Jones recalls a war time letter from Great Britain’s Minister of Supply Lord Beaverbrook written to Prime Minister Winston Churchill:
“On Sunday Morning I came to an understanding with Jesse Jones about production of Rubber”…He has an understanding to give us 50,000 tons of synthetic rubber per annum”…”Do you want tin? It is a Jesse Jones Business.”
Why are Americans not being told about the practical models of the RFC and BND by their media pundits, political leaders, and academic experts in the areas of finance and economics? It seems we have collective amnesia about how the RFC created the World War II prosperity and the economic recovery from the Great Depression which helped improve the global economy. Equally troubling is why there isn’t more recognition of the present economic success stories in the state of North Dakota and the impact of its state owned bank and related financial institutions. The reality is that there are enormous pressures and incentives being brought to bear by the powerful financial lobby whose interest run contrary to the majority. They are attempting to exclude practical and proven financial reforms because it represents a threat to their interests.
The vast majority of Americans sense there is something amiss with the banks and financial pundits, and the time now seems ripe politically for the growing economic discontent of Americans to translate into effective action by their political leaders. The current national debate about jobs and debt ought to now be focused back onto banks. At present the needed financial and banking reform efforts are being blocked at the federal level. However, state and local government leaders can move forward and make change proactively on their own. California and other states simply need to use their funds to create publicly owned banks, and that is when a real economic recovery will begin.
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