State Treasurer's Comments on Washington Investment Trust
Contact: Chris McGann 360-902-9033
January 31, 2012 - Washington State Treasurer James McIntire attended House and Senate Financial Institutions Committee hearings last week to provide testimony about bills that would establish a state bank. (HB 2434 and SB 6310 - Creating a Washington investment trust). Those who are following this issue may be interested in Treasurer McIntire’s comments.
Treasurer's Testimony:
Thank you for this opportunity to testify. My office has prepared a fiscal note and detailed legal and operational analysis of the language for HB 2434/SB 6310. You should have a copy of this analysis in front of you. I will summarize this analysis in my comments today.
How the Treasury Works
Let me begin by offering a brief overview of how the treasury works. Revenues are deposited by agencies and taxpayers in the state’s concentration account. After warrants presented for payment and ACH payments are paid, this account is emptied multiple times each day by investment staff in my office. We invest all of these funds in federally guaranteed securities with an average maturity of between one and two years – earnings on these investments accrue proportionately to state funds with positive balances as directed by law.
Core Principles of a Public Treasury
The core principles of a public treasury are safety (so we don’t lose any money), liquidity (so we can spend the money, all of it if necessary) and only then do we seek to earn a return on the money in the Treasury. Safety, liquidity, and return – in that order. This bill violates these principles.
All public treasury funds deposited in banks in Washington are either insured or fully collateralized - that is, backed by securities of equal value and held by a third party. The proposed Trust would provide neither, but instead would require that any losses be made up by the taxpayers. This is risky. The reason we have this requirement is that we’ve had 20 banks fail in the last 3 years - and before we had this requirement we lost public funds.
Currently we have about $2.8 billion in the Treasury, about one month’s total expenditures. Every spring for the past two years, that figure drops to somewhere around $1 billion to $1.5 billion - just before we receive our spring property tax payments. A significant portion of the balance at that time can be proceeds from bond sales, which federal tax law prohibits us from using for anything except the capital projects for which the bonds were issued. Because our cash needs can fluctuate by as much as $600 million in one day, cash liquidity can be pretty thin and we absolutely must maintain some cushion. Both I and my predecessor have had to warn the Legislature about running out of cash. We need to maintain this liquidity.
The proposed legislation anticipates that Treasury funds would be deposited in the Trust at some point, without regard for the liquidity requirements of the state or the requirements of federal tax law for bond proceeds. These funds would presumably be used for illiquid investments in public infrastructure and student loans - investments that could not easily be sold in a secondary market should the funds be needed for appropriated state expenditures.
Over the past 4 years, the return on the Treasury’s investments in safe, liquid, federal securities has generated half a billion dollars for Washington’s funds, generating revenue for education, health care, social services, public safety, transportation projects and other public services. These returns are paid proportional to the balances in each of Washington’s more than 400 funds. The proposed legislation makes no provision for paying interest on the state funds deposited in the Trust, instead would retain all income generated by state deposits, and would only return net income not needed for operations of the Trust to the General Fund.
It is important to note that an entity of this nature would likely require substantial capital appropriations (not financed by tax-exempt bonds) that would carry it through several years of negative returns before it could turn profitable.
Public Frustration With Banks
I share the public’s anger with big banks for their risks and bailouts, for fees and fraudulent foreclosures, for ballooning bonuses and gratuitous greed - with no hint of gratitude for survival. The banks got rescued and many people who worked hard and played by the rules got screwed. I don’t blame people for being upset - they should be.
There are those who want some form of state bank as a way of punishing Bank of America. "Take all of our money out of Bank of America and put it in our own bank," they say, "so we can control our own money and financing and the interest generated by those transactions."
I need to correct a misimpression. Yes, we have a contract to concentrate our revenues and process transactions - about $290 billion a year. But no, they don’t get to "use" our money. Every morning 6 of my state employees come to work at 5:30 and drain the concentration account, investing our cash in guaranteed, federal government securities - earning about 1.5% on maturities averaging about a year - even in today’s market. This money is not in a bank or on Wall Street, it is invested in federal government securities. WE ARE IN CONTROL OF OUR OWN MONEY! The Treasury is a big enough player to drive competitive procurement bids for banking services - even among the big banks - and to invest our funds ourselves for the state’s benefit. We are the "state’s banker."
It is unclear what advocates want from a state bank. Do they want to compete with community banks, or do they want to provide loans for borrowers who cannot obtain financing from more than 80 community banks across the state? If it is the former, why should the state subsidize it and exempt it from regulation? If it is the latter, how is being a lender of last resort a sustainable, viable business model? What do the proponents of a state bank expect from such an institution that cannot be provided by the other 80 Washington community banks?
Some have argued that they want such a bank to partner with community banks. Washington already has partnership programs with scores of community banks to provide as many short term deposits as they wish at competitive rates that we set, and to provide low-cost deposits that can be used for loans to women, minority and veteran owned small businesses through our Linked Deposit Program.
The North Dakota Model
Many people have pointed to the State Bank of North Dakota - in a state with budget surpluses and an unemployment rate of 3.3% - as a model that works. I spent 5 days there last summer at a treasurer's conference and did some investigation. Here’s what they don't tell you.
Banking is a pretty stable business in agrarian North Dakota. During the last 10 years they didn't have a housing bubble, no banks failed, and the Great Recession passed them by - unlike Washington where 15% of our banks failed. Banking is riskier in a more dynamic economy.
Like the proposed Trust, North Dakota deposits all of their state treasury in their Bank. None of these deposits are insured or collateralized. They are not a member of the FDIC. Their loses are backed by the taxpayers.
The Bank of North Dakota invests in mortgages and real estate, loans to businesses, students, farmers, community infrastructure and lots of other illiquid things that may or may not make their payments. How can they afford to make these illiquid investments? Because they have a bigger treasury.
We have $2.8 billion in our Treasury - about one month’s expenditures. North Dakota's treasury is about $3.5 billion - three quarters of their annual expenditures. We would need $28 billion in our Treasury to have this kind of liquidity.
One of the reasons their treasury is so robust is that they recently discovered oil and gas - enough to account for 25% of their state revenues. This is the reason their unemployment rate is 3.3% - not because they have a state bank.
The interest rate on North Dakota's money is, by law, only the average of the private banks in the state for comparable maturities, and their dividends on capital have been quite modest. Our returns regularly outpace private benchmarks and have totaled half a billion in the past 4 years.
Student Loans and Infrastructure Bank Issues
The stated purpose of the proposed Trust is "improving public infrastructure and increasing access to education," although it is not clear if these investments are to be financed from Trust deposits or revenues from existing programs, or both.
Washington already has the statutory framework for a low-cost student loan program that was enacted in 2007. I know, I was the prime sponsor. The intent was to use tax exempt private activity bonds, issued by the Washington Housing Finance Commission, to finance low cost student loans. However, shortly after the legislation was enacted, the federal government launched its student loan program offering loans at costs lower than what the state could offer. It is unclear how the proposed Trust could possibly provide lower costs than the federal government without a direct subsidy.
Washington has several programs for financing state and local public infrastructure, including the Public Works Trust Account, the Department of Ecology's Clean Water Program, the Department of Health's Drinking Water Program, and the Housing Trust Fund - not to mention all of the programs and investments of the state capital and transportation budgets. All of these programs may or may not be captured by the proposed Trust, but it is unclear how it would possibly create any additional funding to expand these investments beyond the funding, and financing, already available.
My office would be happy to work with this Committee and the Legislature to find ways to meet these objectives without the creation of a costly new entity with a high-priced president. For example, we already have a capable staff administering the State Need Grant for students pursuing higher education - they could easily administer a low cost loan program if the state were to identify a source of funds and subsidize the loans.
Last year, my office proposed restructuring the Public Works Trust Account and creating a Contingent Loan Program to provide credit enhancement for local investments in public infrastructure. We called it an Infrastructure Bank. We would be delighted to work with you to see if we could structure a more efficient combination of several of our infrastructure programs across multiple agencies.
I support the objectives of the bill's proponents, but you must understand that there are financial limits to the state’s ability to finance investments, and no institutional, constitutional or statutory changes can alter that financial reality.
Operational and Legal Issues Summary
Our detailed analysis of this proposal identified several operational and legal issues that would need to be resolved before proceeding with the proposed Investment Trust. Following is a brief summary of some of them:
- Potential violations of the Article VIII, Section 4 and Article VII, Section 6 requirements that all payments of state moneys be paid into the State Treasury, and then appropriated by legislative action.
- Issues involving the State Constitution’s prohibitions on loans of state money, lending of the state’s credit for private purposes, and investments of public funds in private securities (Article VIII, Sections 5 & 7, Article XII, Section 9).
- The requirement of Article II, Section 37, and amendments to statutes be accomplished by setting forth each amended section in full and clearly showing the changes.
- Chapter 43.08 RCW sets forth the responsibilities of the State Treasurer. Some of these duties overlap and conflict with sections of SB 6310. For example, RCW 43.08.010 states that one of the general duties of the State Treasurer is to "keep all moneys of the state . . . ."
- Chapter 43.88 RCW establishes budgeting, accounting, and reporting requirements. In particular, RCW 43.88.160(5) states that "receive, keep, and disburse all public funds of the state not expressly required by law to be received, kept, and disbursed by some other persons . . . ." and "receive, disburse, or transfer public funds under the treasurer’s supervision or custody." Given that a significant portion of public funds held by the Treasurer will be transferred to the Trust, there is no accounting mechanism under this statute for these funds.
- Chapters 43.79A and 43.84 set forth the distribution of earnings among the various accounts held in the state treasury or in the custody of the State Treasurer. These statutes would need to be amended to reflect SB 6310's authorization that investment earnings be deposited in the general fund.
- Chapter 43.85, State Depositaries, "allows investment in public depositaries to occur while remaining in the state treasury so long as the public depositary has fully complied with all requirements of law and the regulations of the public deposit protection commission . . . ." By definition, the Trust is exempt from compliance with these regulations.
- Chapter 43.86A, Surplus funds—investment program requires that certain funds be made available for certain investments. In particular, funds allocated to the time certificate of deposit and the Linked deposit program will likely need to be amended.