New Legislation Prohibiting Debt Assistance Meanspirited & Misunderstands Money

MattBrickWall.jpgThe United States Congress is contemplating a bill, which will probably pass, to "prohibit the provision of Federal funds to State, territory, and local governments for payment of obligations," and also "to prohibit the Board of Governors of the Federal Reserve System from financially assisting State and local governments . . ."The bill was referred to referred to the House Financial Services Committee the day it was introduced, May 18.

The bill is mean-spirited, posturing, and an unwise way for a government to paint itself into a corner should such bailouts become the only alternative to the chaos of economic collapse. But none of those are the worst thing about the bill. The worst thing about HR 5276 is that it's based on a fundamental misunderstanding of money.

We are on the cusp of a wave of debt defaults among cities, counties, and states. These defaults are the fault of Wall Street (combined with the naivete and, in some cases, the corrupt cynicism of local officials). For several decades now, Wall Street banks, firms, mortgage companies and insurance companies have bamboozled or enticed cities, counties and states into debt swaps, derivatives, obscenely high-interest loans and even more obscene fees that are outlandishly high regardless of the performance of the financial institution managing the deals. It is these deals, and not (as is commonly alleged) the "greed" of local governments, that has pushed so many of these entities to the brink of fiscal ruin. 

Saqib Bhatti, author of the "Dirty Deals" report that has been so widely cited among critics of Wall Street corruption, explains:

Banks typically set the rules of the game. They make recommendations for different types of deals municipalities should be doing, they pitch deals to them. Typically, municipalities may bargain around the margins but largely accept the rules as they’re set by Wall Street . . . cities and states regularly have to borrow money and often the pitch from banks is, “Here’s a way you can borrow for less!” or “Here’s a way you can save some money!” That’s typically how it’s framed, as an exciting new product that can save you money. But what often isn’t factored in there is that new product could have a lot of risks built-in, and those risks actually have a dollar value and a real cost . . . the banks really downplay the risks or misrepresent the likelihood of the risks occurring. Often, government officials are really not aware that the risks could actually materialize. One of the things that’s featured prominently in the report is interest rate swaps. With interest rate swaps, in particular, one of the big problems was that there’s all sorts of risks that were embedded in the deals, and in the paperwork there’s all these disclosures that say these risks exist, but when the banks actually pitched the deals the pitch said not to worry about those risks. Or they would make projections of all the money the city could save but those projections were all based on none of those risks materializing. Especially with products that are relatively new, that are not widely understood and where, frankly, in many cases they haven’t been around long enough to really understand what all the risks are, there is this huge problem that exists. The risks just are not disclosed on a level that they should be and in reality, that’s not just unethical, it’s also illegal and violates the Fair Dealing Standards of the Municipal Securities Ruling Board.

In a more detailed account, Bhatti and Renaye Manley write:

The fee-based business model allows Wall Street banks to make a profit regardless of the financial health of their customers. Banks make their money based on the quantity of loans they make, not the quality of those loans. In fact, clients in poor financial health that constantly need to take out more loans, refinance their loans, or enter into more complex financing structures that entail multiple transactions are more profitable to Wall Street than financially stable customers with plain vanilla loans who can pay their bills on time.10 This is true for banking customers of all stripes – individual consumers, corporate clients, and municipal borrowers. This encourages banks to pursue predatory lending practices, such as steering customers towards financial products that are more expensive, more complex, and contain hidden risks. Unfortunately, working families, small business owners, and state and local governments in particular are easy prey. In the financialized economy, Wall Street firms actually benefit from economic inequality because poor people, struggling small businesses, and tax-starved governments are all great sources of fee revenue.

The most intellectually and ethically offensive thing about the bill is that it specifically forbids the Federal Reserve from helping state and local governments--in particular, from creating money to buy bonds issued by those governments--while it does not prohibit the Fed from doing the same thing, or similar "easing" practices, for the federal government. And that's not just hypocritical. The rhetoric surrounding such a move is that "printing money" to solve fiscal crises is bad. In fact, the power to forgive, relieve, draw down, and re-negotiate debt--and the power to quantitatively ease and create additional money to pay debts--is absolutely within the control of governments. It's done all the time at the federal level, and it could be done by public banks at municipal or state levels. It could be done carefully and judiciously, in a way that doesn't strip borrowing entities of accountability, but also refrains from destroying those entities or forcing them into bankruptcy.

The public banking and new economy movement understands this--but understanding it also coaches one into other conclusions about the illusory nature of debt, the potentiality of a democratized financial system, and the social desirability of "quantitative easing for the people," and those conclusions are unacceptable to the financial oligarchy and the elected officials who currently feed at the oligarchy's trough.

HR 5276 is a cynical, potentially destructive, disaster of a bill, but it's also one that perpetuates a deep ignorance about the nature of money and debt--where they come from, how they are created, and who gets to make those decisions. And that's exactly the kind of policymaking we can expect to continue so long as Wall Street pulls the strings of our political system.

Matt Stannard is a member of the Public Banking Institute's Board of Directors, and is the policy director at Commonomics USA.


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