A lot of virtual ink has been spilled over the on-going economic crisis in California. Lost in the uproar is the fact that 6 other states are also having budget crisis of their own.
Most ideas for solving California's fiscal situation involve draconian cuts and higher taxes. Both are unavoidable at this late date.
However, in every crisis there is opportunity for more radical, progressive, long-term ideas. I would now like to present an idea for comment.
The magnitude of the problem
“Our wallet is empty, our bank is closed and our credit is dried up.”
– Governor Arnold Schwarzenegger, June 2, 2009
Many progressives have rallied around the idea of legalizing marijuana. What was once considered a wacky, fringe idea, now has the support of 56% of California voters.
It's practically an indictment of our political system that America's voters, combined with an unprecedented crisis, have had to force the politicians, kicking and screaming all the way, to even consider this common sense idea.
Legalizing marijuana would bring in $1.2 Billion a year of new revenue, according to one study. It would also save hundreds of millions of dollars in wasted law enforcement expenditures, and eventually free up space in our over-crowded jails.
$1.2 Billion is no small amount, unless you compare it to the $25 Billion state budget deficit.
When you put it into that context, legalizing marijuana is only a large drop in a much larger bucket. We need to think much bigger. And when I say "much bigger" I'm thinking of the amount of money spent that doesn't fix a single pothole, build a single school, provide health care for a single resident, or pay the salary of a single teacher or police officer.
I'm talking about the $4.5 Billion that will be spent this year on interest on past debt, or 4.4% of the state's budget.
That amount will rise to $9.2 Billion by 2017, around 6.1% of the state's budget.
That's a huge amount just by itself, but the numbers could get a lot worse very soon. That's because California's budget stalemate, unless resolved soon, will cause rating agencies to downgrade California's debt to junk status.
The state of California must pass a budget by tomorrow or its credit rating could tumble to junk status. Both Moody's and Standard & Poor's have warned the state of a multinotch downgrade if the state fails to approve a budget. California currently has an A2 rating, the lowest of any state.
Fitch Ratings downgraded California's general obligations Friday to single-A-minus from single-A, citing "the magnitude of the state's financial and institutional challenges and persistent economic and revenue weakening."
For your information, junk bond status starts just below BBB. This is an extremely serious situation because many investment funds, by their own internal rules, will only buy investment grade securities.
If California bonds are downgraded to junk status then these funds will be forced to liquidate billions of dollars worth of bonds in a very short period of time. This will add a liquidity crisis to a fiscal crisis, and bring the entire state to a screeching halt.
And the problems don't stop there.
The state's bond rating is not the only one at risk. The California State Teachers' Retirement System, the second-largest U.S. public pension, may face a lower credit rating as well. S&P told the pension system its credit rating could be cut.
S&P's rating criteria limits a pension fund rating to be no more than three levels higher than the general obligation creditworthiness of the governmental sponsor of the pension fund. As a result, if California's A rating were lowered, the teachers' pension fund's AA rating would also fall, S&P said in a statement.
To give you a better idea of the bond situation, here's a few numbers.
If bond ratings drop to near or below junk status California's debt service payments will go even higher for any debt it may need. Bloomberg reports the value of its bonds maturing in 2037 traded for as little as 83.35 cents on the dollar yesterday to yield 6.27 percent. In May the bond sold for 97.25 cents.
Year after year the Republicans have forced through tax cuts, while the Democrats have defended spending programs. In order to bridge that gap the state has borrowed more and more, and now the bill is coming due.
The problems sound insurmountable and depressing.
But what if I was to tell you that there was a long-term solution to this problem that wouldn't involve draconian spending cuts or massive tax increases? What if I was to tell you that this solution has already been in effect in another state since 1919 and has been working efficiently and without scandal?
If you want to see a very progressive solution to this crisis you must turn your eyes to the most unlikely state in the union for a progressive alternative - North Dakota.
Municipal Rating Scam
Before I go any further I should mention that the whole municipal bond rating system is a taxpayer rip-off.
Every state except Louisiana would be AAA if measured by the scale used for corporate borrowers, according to research by Moody's. Scrapping the municipal scale might save California $5 billion in debt costs on $61 billion of voter-approved debt the state plans to sell over the next 30 years, according to state Treasurer Bill Lockyer.
"The rating agencies have two scales," said Frank, during the second of two hearings on the municipal market since bond insurer downgrades in January pushed higher the variable interest rates many cities and towns pay. "This is not a minor, technical matter because schools, highways, sewers are now costing the public more."
Moody's plans to allow municipal issuers to request a corporate-equivalent rating for their tax-exempt bonds starting in May, Levenstein said. The so-called global scale ratings currently are only available on taxable bonds, and for an extra fee. Frank today called that extra cost "abusive."
This double-standard has been used by Wall Street to force municipal governments to buy "insurance" from such Wall Street firms as MBIA and Ambac in order to get a higher bond rating. It was a scam that worked for many years, but it blew up when the financial crisis hit in mid-2007.
Monoline insurers weren't satisfied with insuring just municipal bonds. They got into subprime mortgages as well. Now the monoline insurers no longer have AAA ratings, thus their reason for existing is gone.
However, the scam of stealing taxpayer money through artificially low bond ratings still exist. Months of congressional investigations and pressure haven't changed Wall Street's attitude a bit. What's more, Obama's proposed reforms almost completely overlook the rating agencies that have failed America repeatedly.
The House has proposed legislative reform, but I'm not holding my breath. Even if the reform bill somehow passes, it would only marginally cut costs. It wouldn't reduce the dependence on Wall Street.
Wall Street's dominance of Washington will continue.
However, that doesn't mean that the states are helpless.
Progressive ideas from the Progressive Era
North Dakota has the lowest unemployment rate in the country, positive economic growth of 7.3% in 2008, and even a budget surplus of $1.2 Billion. What's its secret?
The Nonpartisan League advocated state control of mills, grain elevators, banks and other farm-related industries in order to reduce the power of corporate political interests...
In 1919, NPL candidate Lynn Joseph Frazier, another farmer, won the gubernatorial election with 79% of the vote and immediately adopted the NPL platform.
Frazier was recalled in 1921 during an economic Depression, the recall effort led by the conservative, capitalist Independent Voters Association, but Frazier won a Senate seat the very next year.
However, during Frazier's short stint as governor he created two lasting legacies:
1) The North Dakota Mill and Elevator. It's the largest flour mill in the country, as well as the only state-owned mill.
The facility was built by the state as a way of bypassing what many area wheat farmers considered unfair business practices on the part of the railroads and milling facilities in Minneapolis, Minnesota.
The North Dakota Mill has contributed over 50% of its profits to the state's general fund for the last 35 years. However, in fiscal 2008 the mill saw its first loss since 1994.
2) The Bank of North Dakota. It's this entity that relates to California's situation.
The Bank of North Dakota is a state-owned and-run financial institution. Under state law the bank is the State of North Dakota doing business.
we are the depository for all state tax collections and fees. And so we have a captive deposit base, we pay a competitive rate to the state treasurer....We take those funds and then, really what separates us is that we plow those deposits back into the state of North Dakota in the form of loans. We invest back into the state in economic development type of activities. We grow our state through that mechanism.
All state and local government agencies are required by state law to place their funds in the bank.
What really makes the bank so different is that it functions sort of like a central bank, doing things such as check clearing. It's deposits are guaranteed by the State of North Dakota itself, thus not dependent on FDIC.
The Bank of North Dakota provides such services as Student Loans, Farm Disaster Assistance, community development, real estate financing, and others.
On top of that, the Bank will return $60 million in profits to North Dakota's General Fund this year. Over the last decade they've returned about a third of a billion dollars in profits to the General Fund, for a state of just 600,000 people.
A few hundred million dollars is nice, but its a pittance compared to the larger concept - the state of North Dakota borrows from itself, thus profits from those loans get recycled back into the General Fund.
Let that concept sink in for a moment.
Imagine if California could save $4.5 Billion this year, and more than that every year going forward, by not having to pay interest on past loans. Wouldn't the budget problem look a lot less daunting?
Remember that slightly more than half of the cost of every bond-funded public project goes to interest payments. Now imagine the bond initiative you just voted for getting twice the results with the same amount of money. Wouldn't you vote for something like that?
“I understand that these cuts are very painful and they affect real lives. This is the harsh reality and the reality that we face. Sacramento is not Washington – we cannot print our own money. We can only spend what we have.”
– Governor Arnold Schwarzenegger quoted in Time, May 22, 2009
“Banks actually create money when they lend it. Here’s how it works: Most of a bank’s loans are made to its own customers and are deposited in their checking accounts. Because the loan becomes a new deposit, just like a paycheck does, the bank . . . holds a small percentage of that new amount in reserve and again lends the remainder to someone else, repeating the money-creation process many times.”
This is what the Bank of North Dakota is doing right now.
Not longer would the liquidity threat be an issue. No longer would taxpayers being sending billions in interest payments to out-of-state and foreign creditors. No longer would we be at the mercy of rating agencies on Wall Street. No longer would we even care about executive bonuses on Wall Street (except for you 401k money).
This isn't a short-term solution, but it is a long-term solution.
Lastly, for those of you who think something like this can't be done during a crisis, I give you the historic example of the island of Guernsey.