Concerns are growing that we are heading for another banking crisis, one that could be far worse than in 2008. But this time, there will be no government bailouts. Instead, per the Dodd-Frank Act, bankrupt banks will be confiscating (or "bailing in") their customers' deposits.
That includes local government deposits. The fact that public funds are secured with collateral may not protect them, as explained earlier here. Derivative claims now get paid first in a bank bankruptcy; and derivative losses could be huge, wiping out the collateral for other claims.
In a September 24tharticle titled "5 U.S. Banks Each Have More Than 40 Trillion Dollars In Exposure To Derivatives, Michael Snyder warns:
Trading in derivatives is basically just a form of legalized gambling, and the "too big to fail" banks have transformed Wall Street into the largest casino in the history of the planet. When this derivatives bubble bursts (and as surely as I am writing this it will), the pain that it will cause the global economy will be greater than words can describe.
The too-big-to-fail banks have collectively grown 37% larger since 2008. Five banks now account for 42% of all US loans, and six banks control 67% of all banking assets.
Besides their reckless derivatives gambling, these monster-sized banks have earned our distrust by being caught in a litany of frauds. In an article in Forbes titled "Big Banks and Derivatives: Why Another Financial Crisis Is Inevitable," Steve Denning lists rigging municipal bond interest rates, LIBOR price-fixing, foreclosure abuses, money laundering, tax evasion, and misleading clients with worthless securities.
Particularly harmful to local governments have been interest rate swaps misrepresented as protecting government agencies from higher rates.
Yet as Michael Snyder observes:
At this point our economic system is so completely dependent on these banks that there is no way that it can function without them. . . . We are steamrolling toward the greatest financial disaster in world history, and nobody is doing much of anything to stop it.
Sidestepping the Steamroller
California Governor Jerry Brown sees it coming. Rather than rebuilding the state's crumbling infrastructure, rehiring teachers and other public employees, and taking other steps to restore the Golden State to its former prosperity, he has proposed a constitutional amendment requiring all excess state revenues to go into a rainy day fund to prepare for the next crisis.
But there is a better way forward.
In North Dakota -- the only state to post a budget surplus every year since 2001 -- the state owns its own bank. When the state last went over-budget in 2001 due to the Dot.com crisis, it merely issued itself an extra dividend through the Bank of North Dakota -- the only state-owned depository bank in the country -- and the next year it was back on track.
Other local governments would do well to follow suit, not just for the promising profit potential, but as protection against a "bail in" of public deposits.
Forming their own banks can also protect local governments from a looming and unaffordable rise in municipal bond interest rates. State treasurers fear that the Fed's September 2014 exclusion of municipal bonds from the category of "high quality liquid assets" that big banks must hold will drive up bond rates, as it shrinks the market for those bonds and drives up the interest required to attract buyers.
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