Fox News did a piece this morning on the finacncial plight of California. They brought in a guy with some real estate ideas, including equity accelerators, etc.. but nothing too novel or thought-provoking. They ended with an invitation to viewers to share suggestions on how to fix California’s mess at friends@foxnews.com.

So I sent them this:

On this morning’s show, you guys invited suggestions from viewers regarding California’s financial problems. This might be a challenge to present in your time slot, but here goes:

As anyone who looks at their year-end mortgage interest statement knows, banks make profits charging interest on loans. These profits can be used to increase capital reserves. The current crisis stems primarily from large (so-called systemically important) banks investing their capital reserves in real estate asset bubbles and other leveraged financial instruments which held the promise of big profits, but also big risks. When the values of these instruments collapsed, so did their capital reserves, leaving them bankrupt. Despite massive bailouts, they are still not solvent enough to lend.

But the money they lend is simply credit. All of our money except coins is created by banks when they make loans, in the form of electronic accounting entries, and interest is charged and collected on these accounting entries. Just understanding how banks operate is enough to see the solution. If a private bank can create credit on its books, so can the state of California. It merely needs to form its own responsibly run bank. Under the “fractional reserve” lending system, banks are allowed to extend credit – or create money as loans – in a sum equal to many (10-12) times their deposit base.

Congressman Jerry Voorhis, writing in 1973, explained it like this:
“[F]or every $1 or $1.50 which people – or the government – deposit in a bank, the banking system can create out of thin air (actually through an electronic entry) and by the stroke of a pen some $10 of checkbook money or demand deposits. It can lend all that $10 into circulation at interest just so long as it has the $1 or a little more in reserve to back it up.”

Precedent for this approach is to be found in North Dakota, one of only three states currently able to meet its budget. The Bank of North Dakota, the only state-owned bank in the nation, was established by the legislature in 1919 to free farmers and small businessmen from the clutches of out-of-state bankers and railroad men. Today, North Dakota is not only solvent but now boasts the largest surplus it has ever had.

By law, the State must deposit all its funds in the bank, and the State guarantees its deposits, not the FDIC. Surplus profits are returned to the State’s Treasury. The bank operates as a bankers’ bank, partnering with private banks to loan money to farmers, real estate developers, schools and businesses. It makes 1% loans to startup farms, has a thriving student loan business, and purchases municipal bonds from public institutions.

Looking at California’s budget figures, projected State revenues for 2009 are $128 billion. At a normal reserve requirement of 10%, if California deposited all $128 billion in its own State-owned bank, it could issue $1.28 trillion in loans, far more than it would need to cover its $23 billion budget shortfall. To lend itself the money to cover just the shortfall, it would need only $2.3 billion in deposits and about $2 billion in capital (assuming a conservative 8% capital requirement).

What Sheldon Emry wrote of nations is equally true of States:
“It is as ridiculous for a nation to say to its citizens, ‘You must consume less because we are short of money,’ as it would be for an airline to say, ‘Our planes are flying, but we cannot take you because we are short of tickets.’”

Following North Dakota’s lead, California could create all the credit it needs to balance it’s budget and fund its operations, with money to spare.

Every State could!

Had the Wall Street banks stuck to sound banking principles, instead of engaging in reckless speculation, which our government failed to regulate, we would not be in this situation. But seeing as we are, I think most of your viewers would like the idea of seeing the banks beaten at their own game, and instead of States bonding out to Wall Street to meet their debt obligations and fund infrastructure and social service initiatives, use the banking industry’s own methods, in a responsible way, to fund their budget shortfalls and rebuild their economies.

Most of this information above comes from an idea brought forth by Ellen Hodgson Brown (in California). I also promote the idea at my blog, though I may be a bit more outspoken with my political views than Ellen.

–Wil Martindale

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