Crushing the States, Saving the Banks: The Fed's Generous New Rules
By Ellen Brown, Web of Debt
04 May 20
ongCress seems to be at war with the states. Only $150 billion of its nearly
$3 trillion coronavirus relief package - a mere 5% - has been allocated to
the 50 states; and they are not allowed to use it where they need it most,
to plug the holes in their budgets caused by the mandatory shutdown. On
April 22, Senate Majority Leader Mitch McConnell said he was opposed to
additional federal aid to the states, and that his preference was to allow
states to go bankrupt.
No such threat looms over the banks, which have made out extremely well in
this crisis. The Federal Reserve has dropped interest rates to 0.25%,
eliminated reserve requirements, and relaxed capital requirements. Banks can
now borrow effectively for free, without restrictions on the money's use.
Following the playbook of the 2008-09 bailout, they can make the funds
available to their Wall Street cronies to buy up distressed Main Street
assets at fire sale prices, while continuing to lend to credit cardholders
at 21%.
If there is a silver lining to all this, it is that the Fed's relaxed
liquidity rules have made it easier for state and local governments to set
up their own publicly-owned banks, something they should do post haste to
take advantage of the Fed's very generous new accommodations for banks.
These public banks can then lend to local businesses, municipal agencies,
and local citizens at substantially reduced rates while replenishing the
local government's coffers, recharging the Main Street economy and the
government's revenue base.
The Covert War on the States
Payments going to state and local governments from the Coronavirus Relief
Fund under the CARES Act may be used only for coronavirus-related expenses.
They may not be used to cover expenses that were accounted for in their most
recently approved budgets as of March 2020. The problem is that nearly
everything local governments do is funded through their most recently
approved budgets, and that funding will come up painfully short for all of
the states due to increased costs and lost revenues forced by the
coronavirus shutdown. Unlike the federal government, which can add a
trillion dollars to the federal debt every year without fear of retribution,
states and cities are required to balance their budgets. The Fed has opened
a Municipal Liquidity Facility that may buy their municipal bonds, but this
is still short-term debt, which must be repaid when due. Selling bonds will
not fend off bankruptcy for states and cities that must balance their books.
States are not legally allowed to declare bankruptcy, but Sen. McConnell
contended that "there's no good reason for it not to be available." He said,
"we'll certainly insist that anything we borrow to send down to the states
is not spent on solving problems that they created for themselves over the
years with their pension programs." And that is evidently the real motive
behind the bankruptcy push. McConnell wants states put through a bankruptcy
reorganization to get rid of all those pesky pension agreements and the
unions that negotiated them. But these are the safety nets against old age
for which teachers, nurses, police and firefighters have worked for 30 or 40
years. It's their money.
It has long been a goal of conservatives to privatize public pensions,
forcing seniors into the riskier stock market. Lured in by market booms,
their savings can then be raided by the periodic busts of the "business
cycle," while the more savvy insiders collect the spoils. Today political
opportunists are using a crushing emergency that is devastating local
economies to downsize the public sector and privatize everything.
Free Money for Banks: The Fed's Very Liberal New Rules
Unlike the states, the banks were not facing bankruptcy from the economic
shutdown; but their stocks were sinking fast. The Fed's accommodations were
said to be to encourage banks to "help meet demand for credit from
households and businesses." But while the banks' own borrowing rates were
dropped on March 15 from an already-low 1.5% to 0.25%, average credit card
rates dropped in the following month only by 0.5% to 20.71%, still
unconscionably high for out-of-work wage earners.
Although the Fed's accommodations were allegedly to serve Main Street during
the shutdown, Wall Street had a serious liquidity problem long before the
pandemic hit. Troubles surfaced in September 2019, when repo market rates
suddenly shot up to 10%. Before 2008, banks borrowed from each other in the
fed funds market; but after 2008 they were afraid to lend to each other for
fear the borrowing banks might be insolvent and might not pay the loans
back. Instead the lenders turned to the repo market, where loans were
supposedly secured with collateral. The problem was that the collateral
could be "rehypothecated" or used for several loans at once; and by
September 2019, the borrower side of the repo market had been taken over by
hedge funds, which were notorious for risky rehypothecation. The lenders
therefore again pulled out, forcing the Fed to step in to save the banks
that are its true constituents. But that meant the Fed was backstopping the
whole repo market, including the hedge funds, an untenable situation. So it
flung the doors wide open to its discount window, where only banks could
borrow.
The discount window is the Fed's direct lending facility meant to help
commercial banks manage short-term liquidity needs. In the past, banks have
been reluctant to borrow there because its higher interest rate implied that
the bank was on shaky ground and that no one else would lend to it. But the
Fed has now eliminated that barrier. It said in a press release on March 15:
The Federal Reserve encourages depository institutions to turn to the
discount window to help meet demands for credit from households and
businesses at this time. In support of this goal, the Board today announced
that it will lower the primary credit rate by 150 basis points to 0.25% ..
To further enhance the role of the discount window as a tool for banks in
addressing potential funding pressures, the Board also today announced that
depository institutions may borrow from the discount window for periods as
long as 90 days, prepayable and renewable by the borrower on a daily basis.
Banks can get virtually free loans from the discount window that can be
rolled over from day to day as necessary. The press release said that the
Fed had also eliminated the reserve requirement - the requirement that banks
retain reserves equal to 10% of their deposits - and that it is "encouraging
banks to use their capital and liquidity buffers as they lend to households
and businesses who are affected by the coronavirus." It seems that banks no
longer need to worry about having deposits sufficient to back their loans.
They can just borrow the needed liquidity at 0.25%, "renewable on a daily
basis." They don't need to worry about "liquidity mismatches," where they
have borrowed short to lend long and the depositors have suddenly come for
their money, leaving them without the funds to cover their loans. The Fed
now has their backs, providing "primary credit" at its discount window to
all banks in good standing on very easy terms. The Fed's website states:
Generally, there are no restrictions on borrowers' use of primary
credit..Notably, eligible depository institutions may obtain primary credit
without exhausting or even seeking funds from alternative sources. Minimal
administration of and restrictions on the use of primary credit makes it a
reliable funding source.
What State and Local Governments Can Do: Form Their Own Banks
On the positive side, these new easy terms make it much easier for local
governments to own and operate their own banks, on the stellar model of the
century-old Bank of North Dakota. To fast-track the process, a state could
buy a bank that was for sale locally, which would already have FDIC
insurance and a master account with the central bank (something needed to
conduct business with other banks and the Fed). The state could then move
its existing revenues and those it gets from the CARES Act Relief Fund into
the bank as deposits. Since there is no longer a deposit requirement, it
need not worry if these revenues get withdrawn and spent. Any shortfall can
be covered by borrowing at 0.25% from the Fed's discount window. The bank
would need to make prudent loans to keep its books in balance, but if its
capital base gets depleted from a few non-performing loans, that too
apparently need not be a problem, since the Fed is "encouraging banks to use
their capital and liquidity buffers." The buffers were there for an
emergency, said the Fed, and this is that emergency.
To cover startup costs and capitalization, the state might be able to use a
portion of its CARES Relief Fund allotment. Its budget before March would
not have included a public bank, which could serve as a critical source of
funding for local businesses crushed by the shutdown and passed over by the
bailout. Among the examples given of allowable uses for the relief funds are
such things as "expenditures related to the provision of grants to small
businesses to reimburse the costs of business interruption caused by
required closures." Providing below-market loans to small businesses would
fall in that general category.
By using some of its CARES Act funds to capitalize a bank, the local
government can leverage the money by 10 to 1. One hundred million dollars in
equity can capitalize $1 billion in loans. With the state bank's own
borrowing costs effectively at 0%, its operating costs will be very low. It
can make below-market loans to creditworthy local borrowers while still
turning a profit, which can be used either to build up the bank's capital
base for more loans or to supplement the state's revenues. The bank can also
lend to its own government agencies that are short of funds due to the
mandatory shutdown. The salubrious effect will be to jumpstart the local
economy by putting new money into it. People can be put back to work, local
infrastructure can be restored and expanded, and the local tax base can be
replenished.
The coronavirus pandemic has demonstrated not only that the US needs to free
itself from dependence on foreign markets by rebuilding its manufacturing
base but that state and local governments need to free themselves from
dependence on the federal government. Some state economies are larger than
those of entire countries. Gov. Gavin Newsom, whose state ranks as the
world's fifth largest economy, has called California a "nation-state." A
sovereign RSN Fundraising Banner
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Mitch McConnell. (photo: CNN)
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Crushing the States, Saving the Banks: The Fed's Generous New Rules
By Ellen Brown, Web of Debt
04 May 20
ongress seems to be at war with the states. Only $150 billion of its nearly
$3 trillion coronavirus relief package - a mere 5% - has been allocated to
the 50 states; and they are not allowed to use it where they need it most,
to plug the holes in their budgets caused by the mandatory shutdown. On
April 22, Senate Majority Leader Mitch McConnell said he was opposed to
additional federal aid to the states, and that his preference was to allow
states to go bankrupt.
No such threat looms over the banks, which have made out extremely well in
this crisis. The Federal Reserve has dropped interest rates to 0.25%,
eliminated reserve requirements, and relaxed capital requirements. Banks can
now borrow effectively for free, without restrictions on the money's use.
Following the playbook of the 2008-09 bailout, they can make the funds
available to their Wall Street cronies to buy up distressed Main Street
assets at fire sale prices, while continuing to lend to credit cardholders
at 21%.
If there is a silver lining to all this, it is that the Fed's relaxed
liquidity rules have made it easier for state and local governments to set
up their own publicly-owned banks, something they should do post haste to
take advantage of the Fed's very generous new accommodations for banks.
These public banks can then lend to local businesses, municipal agencies,
and local citizens at substantially reduced rates while replenishing the
local government's coffers, recharging the Main Street economy and the
government's revenue base.
The Covert War on the States
Payments going to state and local governments from the Coronavirus Relief
Fund under the CARES Act may be used only for coronavirus-related expenses.
They may not be used to cover expenses that were accounted for in their most
recently approved budgets as of March 2020. The problem is that nearly
everything local governments do is funded through their most recently
approved budgets, and that funding will come up painfully short for all of
the states due to increased costs and lost revenues forced by the
coronavirus shutdown. Unlike the federal government, which can add a
trillion dollars to the federal debt every year without fear of retribution,
states and cities are required to balance their budgets. The Fed has opened
a Municipal Liquidity Facility that may buy their municipal bonds, but this
is still short-term debt, which must be repaid when due. Selling bonds will
not fend off bankruptcy for states and cities that must balance their books.
States are not legally allowed to declare bankruptcy, but Sen. McConnell
contended that "there's no good reason for it not to be available." He said,
"we'll certainly insist that anything we borrow to send down to the states
is not spent on solving problems that they created for themselves over the
years with their pension programs." And that is evidently the real motive
behind the bankruptcy push. McConnell wants states put through a bankruptcy
reorganization to get rid of all those pesky pension agreements and the
unions that negotiated them. But these are the safety nets against old age
for which teachers, nurses, police and firefighters have worked for 30 or 40
years. It's their money.
It has long been a goal of conservatives to privatize public pensions,
forcing seniors into the riskier stock market. Lured in by market booms,
their savings can then be raided by the periodic busts of the "business
cycle," while the more savvy insiders collect the spoils. Today political
opportunists are using a crushing emergency that is devastating local
economies to downsize the public sector and privatize everything.
Free Money for Banks: The Fed's Very Liberal New Rules
Unlike the states, the banks were not facing bankruptcy from the economic
shutdown; but their stocks were sinking fast. The Fed's accommodations were
said to be to encourage banks to "help meet demand for credit from
households and businesses." But while the banks' own borrowing rates were
dropped on March 15 from an already-low 1.5% to 0.25%, average credit card
rates dropped in the following month only by 0.5% to 20.71%, still
unconscionably high for out-of-work wage earners.
Although the Fed's accommodations were allegedly to serve Main Street during
the shutdown, Wall Street had a serious liquidity problem long before the
pandemic hit. Troubles surfaced in September 2019, when repo market rates
suddenly shot up to 10%. Before 2008, banks borrowed from each other in the
fed funds market; but after 2008 they were afraid to lend to each other for
fear the borrowing banks might be insolvent and might not pay the loans
back. Instead the lenders turned to the repo market, where loans were
supposedly secured with collateral. The problem was that the collateral
could be "rehypothecated" or used for several loans at once; and by
September 2019, the borrower side of the repo market had been taken over by
hedge funds, which were notorious for risky rehypothecation. The lenders
therefore again pulled out, forcing the Fed to step in to save the banks
that are its true constituents. But that meant the Fed was backstopping the
whole repo market, including the hedge funds, an untenable situation. So it
flung the doors wide open to its discount window, where only banks could
borrow.
The discount window is the Fed's direct lending facility meant to help
commercial banks manage short-term liquidity needs. In the past, banks have
been reluctant to borrow there because its higher interest rate implied that
the bank was on shaky ground and that no one else would lend to it. But the
Fed has now eliminated that barrier. It said in a press release on March 15:
The Federal Reserve encourages depository institutions to turn to the
discount window to help meet demands for credit from households and
businesses at this time. In support of this goal, the Board today announced
that it will lower the primary credit rate by 150 basis points to 0.25% ..
To further enhance the role of the discount window as a tool for banks in
addressing potential funding pressures, the Board also today announced that
depository institutions may borrow from the discount window for periods as
long as 90 days, prepayable and renewable by the borrower on a daily basis.
Banks can get virtually free loans from the discount window that can be
rolled over from day to day as necessary. The press release said that the
Fed had also eliminated the reserve requirement - the requirement that banks
retain reserves equal to 10% of their deposits - and that it is "encouraging
banks to use their capital and liquidity buffers as they lend to households
and businesses who are affected by the coronavirus." It seems that banks no
longer need to worry about having deposits sufficient to back their loans.
They can just borrow the needed liquidity at 0.25%, "renewable on a daily
basis." They don't need to worry about "liquidity mismatches," where they
have borrowed short to lend long and the depositors have suddenly come for
their money, leaving them without the funds to cover their loans. The Fed
now has their backs, providing "primary credit" at its discount window to
all banks in good standing on very easy terms. The Fed's website states:
Generally, there are no restrictions on borrowers' use of primary
credit..Notably, eligible depository institutions may obtain primary credit
without exhausting or even seeking funds from alternative sources. Minimal
administration of and restrictions on the use of primary credit makes it a
reliable funding source.
What State and Local Governments Can Do: Form Their Own Banks
On the positive side, these new easy terms make it much easier for local
governments to own and operate their own banks, on the stellar model of the
century-old Bank of North Dakota. To fast-track the process, a state could
buy a bank that was for sale locally, which would already have FDIC
insurance and a master account with the central bank (something needed to
conduct business with other banks and the Fed). The state could then move
its existing revenues and those it gets from the CARES Act Relief Fund into
the bank as deposits. Since there is no longer a deposit requirement, it
need not worry if these revenues get withdrawn and spent. Any shortfall can
be covered by borrowing at 0.25% from the Fed's discount window. The bank
would need to make prudent loans to keep its books in balance, but if its
capital base gets depleted from a few non-performing loans, that too
apparently need not be a problem, since the Fed is "encouraging banks to use
their capital and liquidity buffers." The buffers were there for an
emergency, said the Fed, and this is that emergency.
To cover startup costs and capitalization, the state might be able to use a
portion of its CARES Relief Fund allotment. Its budget before March would
not have included a public bank, which could serve as a critical source of
funding for local businesses crushed by the shutdown and passed over by the
bailout. Among the examples given of allowable uses for the relief funds are
such things as "expenditures related to the provision of grants to small
businesses to reimburse the costs of business interruption caused by
required closures." Providing below-market loans to small businesses would
fall in that general category.
By using some of its CARES Act funds to capitalize a bank, the local
government can leverage the money by 10 to 1. One hundred million dollars in
equity can capitalize $1 billion in loans. With the state bank's own
borrowing costs effectively at 0%, its operating costs will be very low. It
can make below-market loans to creditworthy local borrowers while still
turning a profit, which can be used either to build up the bank's capital
base for more loans or to supplement the state's revenues. The bank can also
lend to its own government agencies that are short of funds due to the
mandatory shutdown. The salubrious effect will be to jumpstart the local
economy by putting new money into it. People can be put back to work, local
infrastructure can be restored and expanded, and the local tax base can be
replenished.
The coronavirus pandemic has demonstrated not only that the US needs to free
itself from dependence on foreign markets by rebuilding its manufacturing
base but that state and local governments need to free themselves from
dependence on the federal government. Some state economies are larger than
those of entire countries. Gov. Gavin Newsom, whose state ranks as the
world's fifth largest economy, has called California a "nation-state." A
sovereign nation-state needs its own bank.nation-state needs its own bank.