How California Could Get Its Money Out of Wall Street

The world’s fifth largest economy could keep the money in a state-owned bank to fund local infrastructure.

A public bank can keep the state’s own funds at home working for the state.

Illustration by lvcandy/Getty Images

California needs to spend more than $700 billion on infrastructure over the next decade. Where will this money come from? The $1.5 trillion infrastructure initiative unveiled by President Trump in February includes only $200 billion in federal funding for infrastructure projects across the U.S., and less than that after factoring in the billions in tax cuts in infrastructure-related projects.

The rest is to come from cities, states, private investors, and public-private partnerships. And since city and state coffers are depleted, that chiefly means private investors and PPPs, which have a shady history at best.

At the same time, California has over $700 billion parked in private banks earning minimal interest, private equity funds that contributed to the affordable housing crisis, and “shadow banks”—unregulated financial institutions of the sort that caused the banking collapse of 2008. If California had a public infrastructure bank chartered to take deposits, some of these funds could be used to generate credit for the state while remaining safely on deposit in the bank.

California’s $700 billion is in funds of various sorts tucked around the state, including $500 billion in CalPERS and CalSTRS, the state’s massive public pension funds. These pools of money are restricted in how they can be spent and are either sitting in banks drawing a modest interest or invested with Wall Street asset managers and private equity funds. Those funds are not obligated to invest the money in California, and are vulnerable to losses from Wall Street’s tendency to overextend itself into risky investments. In 2009, for example, CalPERS and CalSTRS reported almost $100 billion in losses from investments gone awry.

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In 2017, CalSTRS allocated $6.1 billion to private equity funds, real estate managers, and co-investments, including $400 million to a real estate fund managed by Blackstone Group, the world’s largest private equity firm, notorious for buying up distressed properties after the 2008 housing market collapse. Another $200 million was given to BlackRock, the world’s largest shadow bank.

CalPERS is now in talks with BlackRock over management of its $26 billion private equity fund, with discretion to invest that money as it sees fit. But that decision would cost the state substantial sums in fees (management fees for CalPERS made up 14 percent of private equity profits in 2016), and there are risks. In 2009, BlackRock defaulted on a New York real estate project that left CalPERS $500 million in the hole. There are also potential conflicts of interest, as BlackRock or its managers have controlling interests in companies that could be steered into deals with the state.

In 2015, the company was fined $12 million by the SEC for that sort of conflict; and in 2015, it was fined $3.5 million for providing flawed data to German regulators. BlackRock also invests clients’ money in companies like oil company Exxon and food and beverage company Nestle, which have been criticized for not serving California’s interests and exploiting state resources.

California public entities also have $2.8 billion invested in CalTRUST, a money market fund managed by BlackRock. Money market funds remain unregulated, although it was a run on money market funds that triggered the 2008 credit crisis.

The infrastructure bank option

There is another alternative. California’s pools of idle funds can’t be spent because they must be saved for a “rainy day” or for future pension fund payouts; but they could be deposited or invested in a publicly owned bank, where they could form the deposit base for infrastructure loans. California is now the fifth largest economy in the world, trailing only Germany, Japan, China, and the United States. Germany, China, and other Asian countries are addressing their infrastructure challenges through public infrastructure banks that leverage pools of funds into loans for needed construction.

China not only has its own China Infrastructure Bank, but also has established the Asian Infrastructure Investment Bank, whose members include many Asian and Middle Eastern countries, including Australia, New Zealand, and Saudi Arabia. Both banks are helping to fund China’s trillion-dollar “One Belt One Road” infrastructure initiative.

Germany has an infrastructure bank called KfW which is larger than the World Bank and had assets of $600 billion in 2016. Along with the public Sparkassen banks, KfW has funded Germany’s green energy revolution. Renewables generated 41 percent of the country’s electricity in 2017, up from 6 percent in 2000, earning the country the title “the world’s first major green energy economy.” Public banks provided over 72 percent of the financing for this transition.

The IBank could be expanded to address California’s infrastructure needs.

As for California, it already has an infrastructure bank: the California Infrastructure and Development Bank, also known as IBank. But the IBank is a “bank” in name only. It cannot take deposits or leverage capital into loans. What IBank does have is the ability to save the state a lot of money. Financing infrastructure through the municipal bond market accounts for half the cost of infrastructure due to the debt load involved.

One example where this is made clear is with Proposition 68, a statewide ballot measure that voters approved in the June 5 primary election which authorizes $4.1 billion in bonds for parks, environmental, and flood protection programs. The true cost of the measure is $200 million per year over 40 years in additional interest, bringing the total to $8 billion. California’s IBank, which funds infrastructure at 3 percent, could finance the same bill over 30 years for $2.1 billion—a nearly 50 percent reduction.

That’s if it were adequately capitalized, but IBank is seriously underfunded because the California Department of Finance returned over half of its allotted funds to the General Fund to repair the state’s budget after the dot-com market collapse in 2001. However, IBank has 20 years’ experience in making prudent infrastructure loans at below municipal bond rates, and its clients are limited to municipal governments and other public entities, making them safe bets underwritten by their local tax bases. The IBank could be expanded to address California’s infrastructure needs, drawing deposits and capital from its many pools of idle funds across the state and reducing costs significantly.

A better use for pension money

In an illuminating 2017 paper for University of California, Berkeley’s Haas Institute titled “Funding Public Pensions,” policy consultant Tom Sgouros showed that the push to put pension fund money into risky high-yield investments comes from a misguided application of accounting rules.

The error results from treating governments like private companies that can be liquidated out of existence. He argues that public pension funds can be safely operated on a pay-as-you-go basis, just as they were for 50 years before the 1980s. Payments to pensioners can be guaranteed by the state, which legally cannot go bankrupt and has a perpetual tax base to draw on.

A public bank can keep the state’s own funds at home working for the state.

That accounting change would take the pressure off the pension boards and free up hundreds of billions of dollars in taxpayer funds. Some portion of that money could then be deposited in publicly owned banks, which in turn could generate the low-cost credit needed to fund the infrastructure and services that taxpayers expect from their governments.

Note that these deposits would not be spent. Pension funds, rainy day funds, and other pools of government money can provide the liquidity for loans while remaining on deposit in the bank, available for withdrawal on demand by the government depositor.

Even mainstream economists now acknowledge that banks do not lend their deposits but actually create deposits when they make loans. The bank borrows as needed to cover withdrawals, but not all funds are withdrawn at once. And a government bank can borrow its own deposits much more cheaply than local governments can borrow on the bond market. Through their own public bank, government entities can thus effectively borrow at bankers’ rates plus operating costs, cutting out go-betweens.

Unlike borrowing through bonds, which merely recirculate existing funds, borrowing from a bank creates new money, which will stimulate economic growth and come back to the state in the form of new taxes and pension premiums. A working paper published by the San Francisco Federal Reserve in 2012 found that one dollar invested in infrastructure generates at least two dollars in GSP (state GDP), and roughly four times more than average during economic downturns.

A public bank can keep the state’s own funds at home working for the state. By expanding California’s existing infrastructure bank into a chartered bank authorized to take deposits of public money, the state can leverage its existing funds into municipal loans to meet its infrastructure needs while the funds remain safely on deposit in the bank.

This article was originally published on and has been edited and condensed for YES! Magazine.

This article was updated June 7 to correct a typographical error: the additional cost of Proposition 68 is $200 million per year in interest, not $200 billion per year.