What if a change in federal law would bring about economic growth by freeing up billions of dollars to be invested in the economy that would benefit all Americans? Shouldn’t there be strong support from all sides of the political spectrum for taking such a step?
At a time when economic growth is at just 1.2 percent, and the economy hasn’t grown much since the start of the Great Recession in 2008, the Federal Reserve could inject capital into the economy by giving the banks their money back.
Federal law requires U.S. national banks to buy stock from the Federal Reserve Bank as a condition of Federal Reserve membership, for which they are paid $110 million in dividend every year. This dividend has been 6 percent in the past, but it has been reduced to 2 percent in the highway funding bill Congress passed last year. But Congress could change the law, make all of this capital “callable,” which would eliminate the need to pay this dividend to the banks, and would free up billions of dollars in capital for loans to small businesses, creation of jobs or financing of home purchases or other investments.
Requiring the banks to buy the stock from the Federal Reserve takes billions of dollars out of the economy each year and locks it up in the vaults of the Federal Reserve Banks. It is not necessary to lock up this capital to ensure a safe and sound financial system, but yet it is still done.
While critics may call this a giveaway to the banks, it is quite the opposite. Right now, the banks are required to buy the stock, and then because of that, receive the 6 percent dividend. The reduction of the dividend to just 2 percent in the highway funding bill has turned the Federal Reserve stock, which the banks are still required to purchase, into a money-losing asset for the banks. Clearly, the banks would rather deploy this money into the economy rather than keeping it on the sidelines at the Federal Reserve.
Some will be concerned that freeing up this capital would affect the structure of the Federal Reserve System. The proposed change would retain the 6 percent capital position for the Federal Reserve Banks, but instead of having 3 percent paid-in and 3 percent callable, there would be a 0.5 percent paid-in and 5.5 percent callable.
The change should have no effect on the Federal Reserve System because Federal Reserve officials have stated publicly that because it can create money, the Federal Reserve does not need paid-in capital or capital surplus because it can never be truly insolvent in the traditional sense.
A recent Federal Reserve publication explained that capital is not needed to absorb operating losses, since under its accounting policy any operating losses are recorded on its books as a “deferred asset” that is retired by subsequent earnings. During that period, remittances by the Federal Reserve of its earnings to the U.S. Treasury is suspended.
The paid-in versus callable mix will not affect loss absorbency because the stock is not loss absorbent in the way of equity in a private firm. The callable stock would never be called. Furthermore, as a protection to taxpayers, the only way the stock becomes loss absorbent is if a Federal Reserve Bank declares bankruptcy, and that’s not possible. If the Federal Reserve did suffer operating losses, it would simply record a “deferred asset” on its books against that loss rather than writing down paid-in stock and/or calling more.
Losses of the Federal Reserve should not be imposed on the banking system through stock requirements. Good public policy should aim to protect the safety and soundness of banks. Unrelated losses by a government entity should not be imposed on the banking system, especially as those losses are likely to occur during periods of economic distress.
The Federal Reserve has tried everything to try to spur economic growth, and the economy has remained mired at anemic growth levels since 2008. Traditionally, the Federal Reserve lowers interest rates to promote an economic rebound. With interest rates at historically low rates, so low they can hardly go lower, the economy has responded favorably. Why not unleash these millions of dollars of capital to spur investment, business start-ups and growth of existing businesses, and the creation of jobs?
