Looking for a way out of this financial crisis, with just about every state and municipality overextended in debt, I came across a solution offered by Ellen Brown, summarized in her book Web of Debt and in articles on her website at www.webofdebt.com/articles.

If New Jersey were to enact this solution, the State could save billions of dollars in debt service for years to come. The solution is for the State to form its own bank, whose purpose would be to pay off the $40 billion plus in debt it has accumulated. Instead of interest payments going to private investors, the payments will effectively go to the residents of the State. The State would save over $6 billion a YEAR in debt service.

Pouring money into the private banking system has fixed the economy only for bankers and the wealthy; it has not done much to address either the fundamental problem of unemployment or the debt trap so many Americans find themselves in.

President Obama’s $787 billion stimulus plan has so far failed to halt the growth of unemployment: it has now reached 10.2 percent nationally. If one adds those people who are too discouraged to look for work or those working part time because they couldn’t get a full time job, the unemployment rate was 17.5 percent in October. Our nation has not seen these numbers since the Great Depression.

In this dark firmament, however, one bright star shines. The sole state to actually gain jobs is an unlikely candidate for the distinction: North Dakota. North Dakota is also one of only two states expected to meet their budgets in 2010. (The other is Montana.) North Dakota is a sparsely populated state of less than 700,000 people, largely located in cold and isolated farming communities. Yet, since 2000, the state’s GNP has grown 56 percent, personal income has grown 43 percent and wages have grown 34 percent. The state not only has no funding problems, but this year it has a budget surplus of $1.3 billion, the largest it has ever had.

During the past gubernatorial campaign, former Governor Corzine stated that if the people of New Jersey wanted to live in a low un-employment state they should move to North Dakota. Our point is that we can achieve low un-employment and have sound, fiscal government without moving to North Dakota.

Why is North Dakota doing so well, when other states are suffering the ravages of a deepening credit crisis? Its secret seems to be that it has its own credit machine. North Dakota is the only state in the Union to own its own bank. The Bank of North Dakota (BND) was established by the state legislature in 1919, specifically to free farmers and small businessmen from the clutches of out-of-state bankers and railroad men. The bank’s stated mission is to deliver sound financial services that promote agriculture, commerce and industry in North Dakota.

The Advantages of Owning Your Own Bank

So, how does owning a bank solve the state’s funding problems? Isn’t the state still limited to the money it has? The answer is no. Chartered banks are allowed to do something nobody else can do: They can create credit on their books simply with accounting entries, using the magic of “fractional reserve” lending. As the Federal Reserve Bank of Dallas explains on its web site:

“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.”

How many times? Economists put this “multiplier effect” at eight to ten. But it hasn’t worked that way recently, because the books of private banks are impacted by bad derivatives bets, unmarketable collateralized debt obligations and mark-to-market accounting problems. In other words, the banks miscalculated the risks they undertook when they lent their money. For those who pursued the career of banking the old adage “those who can’t do, do banking” seems more relevant than ever.

The Bank of North Dakota (BND) is set up as a dba: “the State of North Dakota doing business as the Bank of North Dakota.” Technically, that makes the capital of the state the capital of the bank. When former Governor Corzine wanted to sell the state’s toll roads, they were valued at approximately $20 billion. Projecting the possibilities of just leveraging this asset alone by a factor of eight, that capital base could support nearly $160 billion in loans.

To get a bank charter, specific investments would probably need to be earmarked by the state as startup capital; but the startup capital required for a typical New Jersey bank is only about $20 million. This is small potatoes and the money would not actually be “spent.” It would just become bank equity, transmuting from one form of investment into another — and a lucrative investment at that. In the case of the BND, the bank’s return on equity is about 25 percent. It pays a hefty dividend to the state, which is expected to exceed $60 million this year. In the last decade, the BND has turned back a third of a billion dollars to the state’s general fund, offsetting taxes.

New Jersey could do substantially better than that. New Jersey pays $6 billion annually in debt service. If it had its own bank, the bank could refinance its debt and return that $6 billion to the state’s coffers; and it would make substantially more on money lent out.

Besides capital, a bank needs “reserves,” which it gets from deposits. For the BND, this too is no problem, since it has a captive deposit base. By law, the state and all its agencies must deposit their funds in the bank, which pays a competitive interest rate to the state treasurer. The bank also accepts deposits from other entities. These copious deposits can then be plowed back into the state in the form of loans.

Our nation has poured trillions into the banking system where funds have gone to shore up their losses and little has been lent back into the economy. Compounding the bank’s inability to lend, the expectations of ever higher tax rates has made most borrowers not willing to take on new borrowing risks. In fact a capital strike has begun in earnest.

Public Banking on the Central Bank Model

The BND’s populist organizers originally conceived of the bank as a credit union-like institution that would free farmers from predatory lenders, but conservative interests later took control and suppressed these commercial lending functions. The BND is now chiefly a “bankers’ bank.” It acts like a central bank, with functions similar to those of a branch of the Federal Reserve. It avoids rivalry with private banks by partnering with them. Most lending is originated by a local bank. The BND then comes in to participate in the loan, share risk and buy down the interest rate.

One of the BND’s functions is to provide a secondary market for real estate loans, which it buys from local banks. Its residential loan portfolio is now $500 billion to $600 billion. This function has helped the state to avoid the credit crisis that afflicted Wall Street when the secondary market for loans collapsed in late 2007. Before that, investors routinely bought securitized loans (CDOs) from the banks, making room on the banks’ books for more loans.

But these “shadow lenders” disappeared when they realized that the derivatives called “credit default swaps” supposedly protecting their CDOs were a highly unreliable form of insurance. In North Dakota, this secondary real estate market is provided by the BND, which has invested conservatively, avoiding the speculative derivatives debacle.

Other services the BND provides include guarantees for entrepreneurial startups and student loans, the purchase of municipal bonds from public institutions and a well-funded disaster loan program. When the city of Fargo was struck by a massive flood recently, the disaster fund helped the city avoid the devastation suffered by New Orleans in similar circumstances; and when North Dakota failed to meet its state budget a few years ago, the BND met the shortfall.

The BND has an account with the Federal Reserve Bank, but its deposits are not insured by the FDIC. Rather, they are guaranteed by the State of North Dakota itself — a prudent move today, when the FDIC is verging on bankruptcy.

The state could earn billions yearly on these loans, while saving hefty sums for consumers. It could also refinance its own debts and those of its municipal governments at very low interest rates. According to a German study, interest composes 30 percent to 50 percent of everything we buy.

For an ordinary State to initiate capitalizing a bank, it would be full speed ahead. However New Jersey wasn’t named “The Soprano State” for nothing. Explicitly stated in its by-laws and lending practices must be strict conservative guidelines that the borrower must have adequate assets and security exist to repay in the event of a default. Otherwise the politicians will, like Tony Soprano, be whacking up loans to their friends and contributors.

New Jersey is faced with an $8 billion dollar deficit. By forming a bank and buying out the bondholders, the State will not only go a long way towards solving the deficit problem but can begin to reinvigorate its ailing economy so that its residents find New Jersey an affordable state to live and work in again.

How to Save NJ Billions:

• New Jersey Form a State Bank
• Capitalize it with enough assets to pay off all State Loans
• Keep Tony Soprano away — Avoid having it become another money pit by establishing strict conservative guidelines in its by-laws and lending practices.
• If done right (see #1–#3) $6 billion in debt service expenses can be eliminated from the State’s operating budget, not just this year but each and every year.