Federal Reserve overreaches again

The Federal Reserve is considering entering real time payments in the United States. If this happens, the modernization apace in this market will stall out. There is no reason for the Federal Reserve to intervene here, except for it to expand once again into an area beyond its mission. For background, most payments conducted by check and electronic transfer take time, sometimes days, to clear to make funds fully available. This creates inefficiencies and inconvenience for customers and businesses that expect better in an age when technology makes everything faster.

The private sector has responded to this need, providing the country with updated capabilities through the Real Time Payments Network, a system launched two years ago. Developed by the Clearing House, it provides for the immediate settlement of transactions. It is delivering convenience and performance to consumers across the economy. But then here comes the Federal Reserve, which has announced that it wants to provide its own real time payments system and envisions working with a “broad array of stakeholders” in the financial industry to introduce a structure that gives the Federal Reserve a new central role in the real time payments market.

{mosads}So what could go wrong? First, the private sector is already successfully addressing this need to speed up and modernize the payments system in the United States, by means of a solution that now reaches over half of the accounts across the country. Second, a system run by the Federal Reserve would likely be unable to interoperate with the private sector system, which would have the effect of bifurcating the market. Think two mobile networks where users can only talk to the people who subscribed to their network. This has been the case in Europe where the private and public real time payments systems are not able to interoperate together.

With two real time payment systems in place, financial institutions would be required to connect to both. This would increase costs, degrade the broad reach and functionality required by such networks, and place the private system at an unnatural competitive disadvantage. The Federal Reserve is already delaying adoption of real time payments as it considers launching its own system. None of this has anything to do with its main responsibilities of holding bank reserves or conducting monetary policy.

Federal Reserve activity in real time payments would chill competition in this developing sphere of enterprise, force “stakeholders” into a cronyist relationship with the government, and depress innovation. It would be yet another example of “mission creep” as the Federal Reserve bounds into a domain beyond its basic purpose. As the great business historian Alfred Chandler taught, economic institutions that propose to go on forever can pose a danger to the national prosperity. An institution that does well in one time and place is wise to consider folding and have the parts remake themselves anew, in different organizations, as the environment changes.

In its push into the fast payments arena, the Federal Reserve defies this classic Chandlerian insight at more than a century old. It now operates in the payments system, but this has likely slowed down development. It will probably be unskilled at supervising the next payments revolution. It is an inherited organization that was set up for a different purpose, and it is not entrepreneurial by nature. If it does make its way into fast payments, the reason will surely not be the excellence of its expertise or the superiority of its product. It will be because it is the chief banking regulator of the nation, and woe to those in the industry that do not play along with it.

Furthermore, the Federal Reserve is prone to making mistakes. The classic case is the early years of the Great Depression when the teenage Federal Reserve oversaw the shuttering of thousands of banks and the wiping out of the financial resources of millions of Americans. When such inherent government power makes mistakes, the effects are felt both far and wide.

If the Federal Reserve enters the new payments system and then proves bad at the job, the results will be worse than if the market had been left to its own devices. The fact is the real time payments revolution is already underway. The Federal Reserve should let the private sector proceed on its perfectly healthy course of modernizing the United States payments system and not make such a gratuitous push for a major role of its own.

Brian Domitrovic is a professor at Sam Houston State University with a focus on economic history. He and Lawrence Kudlow are the authors of “JFK and the Reagan Revolution: A Secret History of American Prosperity.”