Thursday, April 21, 2011

Federal Reserve Paying Banks Interest Rate That Is Eight Times Market Rate

It's probably not clear to most Americans how Fed Chairman Ben Bernanke has changed the rules of the game for the benefit of bankers since he has taken over as chairman. He calls these changes new Federal Reserve "tools".

One important example of  Bernanke's new Federal Reserve "tools" is the paying of interest on deposits that banks leave with the Federal Reserve. It has resulted in over a trillion dollars accumulating at the Fed, as what is known as "excess reserves". The Fed is paying banks EIGHT times equivalent market rates when they keep the funds as excess reserves.

The money bankers deposit with the Fed is totally riskless and also does not require them to hold capital against the deposits. Prior to the Bernanke regime, interest was never paid on these deposits. Alan Greenspan never paid interest on deposits left at the Fed. Paul Volcker didn't. Arthur Burns didn't. In fact, no other Fed chairman in Fed history has done so. But because Bernanke is doing this, banks are racking up totally riskless earnings that no one else in America can get.

For example, Bank of America in its recent quarterly filing with the SEC reported that it earned $63 million dollars for the first quarter in this total riskless way. It's a total bizarre gift from the Fed to the banking sector.

Further, the rate paid by the Fed is more than eight times the rate on one-month T-bills. In other words, if B of A or any other American attempted to find equivalent safety in the marketplace, they would have to invest in one-month Treasury Bills which are paying 0.03%. At the same time, banks are earning 0.25%, if they just leave the money on deposit with Bernanke at the Fed.

If Bank of America placed the money they had with the Fed last quarter in one monthT-Bills, the interest they would have earned would been far under $30 million. (The exact amount would depend on the rate fluctuations in the market).

In total as of April 21, banks have sitting in the warm bosom of the Federal Reserve, as excess reserves, $1.474 trillion.   Over a three month period, this means the Fed will be paying banks nearly $1 billion, if reserves stay at this level. If banks tried to get equivalent market rates that all other Americans and corporations get, for equivalent risk, the banks would be getting only $110 million. In other words, with this new "tool" of Bernanke's, he is gifting banks $890 million every three months. Or a total of $3.56 billion each year. It should be added that this $3.56 billion is money the Fed simply prints up, which has the potential to enter the system causing even more price inflation for the rest of us.

Although Bernanke would argue that the paying of interest on excess reserves is a necessary tool the Fed needs to conduct monetary policy, arguing against this point is the fact that no other Fed chairman has needed such a tool. And although, a point can be raised as to whether the Fed should be manipulating interest rates or money supply at all, the addition of this Bernanke tool suggests, if anything, more monetary volatility in the system. Since Bernanke has started paying interest on reserves and it has become clear the size of funds that have moved in this direction, he has started the process of testing even more new "tools" to control this paying of interest tool. This odd designing of new tools, when the old tools of monetary policy worked fine, suggest very odd behavior by the Fed chairman and could result in dramatic swings in the economy, if one of these tools has not been thought out properly and, thus, results in wild swings in money supply growth.

9 comments:

  1. This new "tool" (paying interest on excess reserves, not Bernanke, just to be clear on "tool") is the reason that doubling the monetary base is only now starting to have the inflationary effects everyone has anticipated. It created a time-bomb for potential hyperinflation when the banks decide to put the excess reserves to work which is inevitable. It's also why the stimulus didn't even have the usual fake Keynesian "kick" -- all the printed money went to reserves instead of the economy. Maybe Bernanke's plan was just to falsely prop up the big banks' books and back it out when things settle down. I doubt he can pull it off. The excess reserves will eventually make their way into the economy.

    ReplyDelete
  2. I would not call any interest rate today a "market" interest rate. Let's just be honest, if the market were setting rates, they would more than likely be in the double digit territory. Just sayin'.

    Also, from my understanding of bank deposits, interest on demand deposits were outlawed in 1934. Reserves held at the Fed constitute demand deposits (those of member banks) held at the Fed. I am just curious if this change was done through Congress, or if the Fed just changed it willy nilly? Anybody know the answer?

    ReplyDelete
  3. Further, with regard to my comment about demand deposits (reserves held at fed), whether are not these changes were Congressional (i.e. Constitutional), or made by the Federal Reserve itself, are they reflected in either Regulation Q or Regulation D? I haven't been able to find it.

    ReplyDelete
  4. I can think of a number of tools the Fed has used in the past that weren't much better, so don't be too kind to previous Fed chairmen.

    ReplyDelete
  5. It's good to be a bank. You get free money to floating your bad investments and then get paid to keep the excess left.

    Seriously, how doesn't this fact cause riots in the streets?

    I'm not sure the lawyers are the worst "profession" in the American economy anymore...it's got to be the bankers. (with pols @ #1 either way)

    ReplyDelete
  6. Federal reserve officials & technicians do not work for the American people. They work for the commercial bankers to the detriment of the American people.

    IORs are just a contrived subsidy to the bankers. They are not as the moron Dr. Milton Friedman maintained a "tax" on the bankers. To the contrary, with fractional reserve banking open market purchases create new inter-bank demand deposits and provide new bank lending capacity. The commercial banks are then able to acquire a multiple expansion of earning assets as a result and the Treasury can recapture SOMA's interest to boot. That is indeed profitable to the participants. In no way is the concommitment increase in CB earning assets a tax.

    ReplyDelete
  7. Thanks for highlighting this. Any insight/opinion on the legal status/mechanism connected to this 'tool' would be appreciated (as raised by earlier post).

    It seems as individuals the best of bad options available for one is to remove deposits from these institutions. Are there alternative views?

    ReplyDelete
  8. This is why the stimulus didn't work. If you were an investor... Would you take risks on business loans at 2-4%, or just put your money in the Fed excess reserve account, with no risk at 8%+.
    So the fed printed money to loan the "member" banks at 1% , then the banks deposit it with the Fed and get 8%+. So the member banks earn enough to pay back the loan in 6yrs and keep the principle. Next who did they pay back? and is that money that was printed get destroyed or is it permanent increase in M? So the fed is these banks, so they lent themselves this mony and paid themselves back. Don't forget the treasury had to borrow the mony to loan the banks. So we pay interest to the fed on money they simply printed. why did the treasury agree to this ? Because if they didn't they would go in default, because we have to borrow from the Fed/ Member banks just to pay the interest on our debt to the fed. And don't forget "to big to fail only refers to Fed "owners" , not an S&L like Wa Mu, But rather Wall Street hedge firms that have no basic bank services, .but were initial investors in the Fed. Also what about those toxic assets from WaMu and Countrywide? well B of A is happy with Countrywide's. Chase is happy w/ only the good assets from WaMu. And how cheap were the not so toxic assets of WaMu that we paid some Investors to handle for us... guess who?

    ReplyDelete
  9. This is why the stimulus didn't work. If you were an investor... Would you take risks on business loans at 2-4%, or just put your money in the Fed excess reserve account, with no risk at 8%+.
    So the fed printed money to loan the "member" banks at 1% , then the banks deposit it with the Fed and get 8%+. So the member banks earn enough to pay back the loan in 6yrs and keep the principle. Next who did they pay back? and is that money that was printed get destroyed or is it permanent increase in M? So the fed is these banks, so they lent themselves this mony and paid themselves back. Don't forget the treasury had to borrow the mony to loan the banks. So we pay interest to the fed on money they simply printed. why did the treasury agree to this ? Because if they didn't they would go in default, because we have to borrow from the Fed/ Member banks just to pay the interest on our debt to the fed. And don't forget "to big to fail only refers to Fed "owners" , not an S&L like Wa Mu, But rather Wall Street hedge firms that have no basic bank services, .but were initial investors in the Fed. Also what about those toxic assets from WaMu and Countrywide? well B of A is happy with Countrywide's. Chase is happy w/ only the good assets from WaMu. And how cheap were the not so toxic assets of WaMu that we paid some Investors to handle for us... guess who?

    ReplyDelete