One of the problems we’re forced to confront when considering the role of the Federal Reserve is whether it’s better for the Fed to take losses and capitalize them as deferred assets, or go back to an era of “Fed profitability” whereby the Fed remitted money to the Treasury on a weekly basis.
The path to profitability is an easy one, consider: Last year the central bank earned $170 billion in interest revenue (paid by government and mortgage holders), then expensed $102 billion to banks, literally 60% of the Fed’s revenue.
What would happen if the Fed simply stopped paying interest to banks?
The chart below shows Reserves held at the Fed since 1959:
The reserves balance held at the Fed didn’t fluctuate for decades and then suddenly banks started keeping a lot more money at the Fed. By 2009 over $1 trillion was held there, and in 2021 over $4 trillion.
This October 6, 2008 announcement solves the mystery:
The Federal Reserve Board on Monday announced that it will begin to pay interest on depository institutions’ required and excess reserve balances.
Required and excess reserve balances no longer exist, they’ve been combined into reserve balances, and so, as the Fed’s FAQ shares:
The Federal Reserve Banks pay interest on reserve balances.
Currently at a generous 4.9%.
The interest rate on the Fed’s US Treasuries held are not disclosed in its financial statements, but the interest rate on its nearly $3 trillion Mortgage-Backed Securities is:
Nearly $2 trillion earns the Fed 1.5% to 2.5%, whereas the Fed pays 4.9% on the $3 trillion that banks hold on reserve. And so, it’s probably time to consider putting an end to this nearly two-decade long experiment of transferring wealth from the poor and middle class to the rich and powerful.
The correct answer is that the Fed should be abolished, but this will not happen anytime soon. Realistically, they could revert to the pre-2008 policy and pay no interest, or because too many people won’t like that, then at least lower the rate paid to banks to something smaller, like 1, 2, or 2.5%. It’s all arbitrary, but anything less than 4.9% would be an improvement.
One might fear that in doing so, this $3 trillion reserve would leave the Fed and go back to the banks; however, this is fine as the world functioned a lot longer in the former way rather than the latter.
Also consider how ideas like liquidity crisis, lending crisis, or credit crunch, have been mentioned since the banking crisis of 2007-09. Lending programs like the Paycheck Protection Program, and all the other bank assistance schemes, appear more suspect when we remind ourselves that the banks had trillions of dollars earning interest at the Fed this entire time. Given that we’re living at a time when the risk of bank-runs have become a real threat, it’s almost comical to think banks would lend “too much,” or wouldn’t benefit by increasing their own reserve amounts, so claims to the contrary seem unfounded.
In a truly free market, a bank would have the ability to either lend money or keep it on reserve as there would be no central bank to offer a third choice. A Fed that does not pay interest on reserves would bring us a step closer to such a market.
It doesn’t bode well that stopping interest payment on reserves or at least reducing the 4.9% rate is not being considered as a viable solution. The fact that the Fed has the power to enact this change, literally tomorrow, but continues not to, speaks volumes. Hopefully there’s another way, but if not, the conclusion is clear: If the Fed refuses to cut expenses by reducing interest paid to banks, then the only way for the Fed to make more money is for the Fed to “make more money.”
