In all the hue and cry about the Federal Reserve’s efforts to raise interest rates to quench the inflationary flames, not much has been said about how these higher rates are raising the Fed’s own payments to banks for money held in reserve — to the tune of around $100 billion this year. This at a time when the Fed itself is apparently running a monthly deficit, the first since 1915, and unable send one thin dime to U.S. taxpayers.
Where does the Fed get all that money? What happens when the money spigot closes? And does it all make sense?
Fed revenues come from interest and capital gains earned on vast holdings of government bonds, as well as for services rendered to Fed member banks. Each year, the Fed normally makes enough money to send a large payment to the U.S. Treasury, and this provides a welcome benefit to U.S. taxpayers. Last year, the Fed sent out a net $107 billion, and the year before $86 billion. This year, the Fed expects to operate with a loss.
Part of tightening the monetary screws means selling off interest-bearing securities and not replacing them. Simply put, Fed revenue is down and Fed costs are up, partly due to accelerating interest payments to banks. We taxpayers are in for leaner times.
A quick look at some numbers will shed light on the bank part of the story. At the end of October, bank reserves held at the Fed totaled a bit more than $3.05 trillion. The current interest rate paid on reserves is 4.40 percent. This was set Dec. 15 when the Fed raised rates for everyone else. (When the Fed raises rates at its regular meetings, the bank rate rises automatically.)
At 4.40 percent (and likely rising), $3 trillion yields about $132 billion in annual Fed payments headed to bank bottom lines. Just a year ago, the Fed was paying only 0.15 percent on bank reserves, which caused banks to get a pale $5.7 billion for $3.8 trillion in reserves.
Why are big checks going to banks in the first place? An important Texas A&M Private Enterprise Research Center policy study authored by Tom Saving provides important background on this and more. It all began in 2008 when the U.S. financial economy was going through the ringer. At the time, the normally independent Fed was deeply engaged with the U.S. Treasury, and together they were working with Congress to shore up beleaguered banks and strong ones, too. In the midst of the Great Recession, Congress legislated, and the Fed followed the orders.
Interest paid on reserves started later that year. At the time, total bank reserves with the Fed stood at a lowly $184 billion. Since then, the level of reserves has become swollen as the Fed bought bonds from the public, which put lots of money in bank accounts and in Fed bank reserves.
Of course, financial markets have adjusted to all this. Bank stocks are most likely less risky than they once were, but clearly times have changed since 2008.
Writing about the Fed’s payment of interest to banks in 2016, former Fed Chair Ben Bernanke and Brookings Institution economist Donald Kohn offered an explanation and justification for the interest payment system. At the time, the interest rate paid on reserves was still quite small (0.25 percent) as were the total payments. Bernanke and Kohn made the point that when interest rates rose significantly, the Fed would have to deal with a public perception problem. Why taxpayers are losing revenues so that big banks, some of which are foreign owned, receive billions in Fed payments was the question to be confronted.
And here we are. It is now 14 years since it all started. Perhaps now is the time to end a program designed partly to buttress a recession-stressed banking system. And perhaps Congress will reexamine the entire matter and consider paring down the payment rate and eventually closing the spigot that now feeds billions of dollars from taxpayers to banks.
Bruce Yandle is a distinguished adjunct fellow with the Mercatus Center at George Mason University and dean emeritus of the Clemson College of Business and Behavioral Sciences.