WASHINGTON — The ease with which Congress was able to take money from the Federal Reserve to pay for a highway transportation bill — by slashing the dividend the central bank pays large banks — is likely to encourage lawmakers to take another dip into the Fed's books next year.
While it's not clear exactly what they might target next, many observers believe it will be the interest the agency pays for excess reserves held at Fed banks.
"Congress is continually looking for money — real or fake — to justify its policies," said Aaron Klein, director of the financial reform initiative at the Bipartisan Policy Center. "I'm very concerned that the movement against the Fed on monetary policy, which is an unwise movement, will target this next."
The test could come early in the next session as House Speaker Paul Ryan attempts to take up a tax reform bill and other priorities. Some lawmakers have already put the interest on Fed reserves in their sights.
During a Joint Economic Committee hearing with Fed Chair Janet Yellen on Dec. 3, GOP presidential hopeful Sen. Ted Cruz made a point of asking about it.
"In 2008, the Fed began paying interest on reserves. In the seven years since then, do you know how much in interest the Fed has paid to banks under that policy?" Cruz said.
Yellen responded that while she didn't have the exact number, interest on paying reserves is a "critically important tool of monetary policy."
"It's a tool that almost all advanced countries have and rely on as a key tool of monetary policy," she said.
The central bank requires member banks to hold a certain amount of cash in an account at a regional Fed bank as a stipulation of membership. The idea is to ensure payments can be conducted smoothly, but the Fed only recently began paying interest for any excess reserves.
Congress gave the Fed power to pay interest on reserves in 2006, partly as a way to reduce volatility in overnight interest rates. A provision in the 2008 bank bailout bill sped up the effective date on that authority, allowing the Fed to pay at a 0.25% rate. The excess reserves in the Fed system have skyrocketed from roughly $10 billion to more than $2.5 trillion today.
The Fed has consistently argued this ability is key monetary policy tool and others have noted it helps preserve the central bank's federal funds rate as the market benchmark. Yet some say it's time for Congress to clip that power. Joseph Gagnon, a senior fellow at the Peterson Institute, published a blog post on Dec. 9 that called on Congress to "take steps to end those unnecessary subsidies."
"Given the large expansion of its balance sheet in recent years, the Fed has to pay interest on most of its liabilities in order to maintain steady growth with low inflation," Gagnon said. "Making such payments does not, by itself, constitute a subsidy. However, the manner in which the Fed has decided to configure its tools means that the Fed has chronically paid banks an above-market rate on their reserve balances."
Karen Shaw Petrou, managing partner of Federal Financial Analytics, said the issue has yet to gain traction — but that could change next year during the next budget battle.
"Right now, it's quiet," she said. "I think it will take its place in next year's fiscal discussions, but most importantly in the near term, because of the nature of the omnibus … when the next omnibus comes up on or around September 30, what are they going to do then?"
For his part, Gagnon said the Fed should have the freedom to raise interest on excess reserves if that's what it feels like it should do. He simply says that there's no good reason for the Fed to cut banks such a good deal. He said the central bank's monetary policy goals could be achieved without the spread between the interest of excess reserves, which only benefits banks, and overnight repos, which can be accessed by all nonbank financial firms. Because those are similar investment vehicles that perform similar functions, the Fed could simply equalize the rate and any tightening from one side would be made up in the economy by loosening on the other, he said.
"They [the Fed] have to be free to raise interest on excess reserves to manage the economy. Anything to prevent that would be a huge problem of them doing their jobs," Gagnon said. "They're similar types of investments — sort of perfectly safe, overnight ways to invest your money. [Taxing reserves] doesn't make sense, but I don't think going to the opposite extreme of always giving the banks more than anyone else can get makes sense either."
But Gagnon also said that this idea of equalizing the IOER and reverse repo markets doesn't lend itself as obviously to budgetary absorption as, say, the Fed dividend or the surplus capital moves did.
"They were able to do this in the last bill on the bank dividends because they were able to identify a stream of payments they could redirect to the budget," Gagnon said. "I'm not sure what language they would use and how they would grab it. Clever lawyers and legislative drafters might come up with something, but that would be a stretch."
Petrou said that the difference between banks and nonbanks — and a reasonable basis for the justification for putting them on the top-end of the spread — is that banks have an important role to play in the economy and are subject to considerable capital and supervisory requirements as a result.
"The cost of being a bank, especially a big one — which is the eligibility criteria to being a member of the Federal Reserve and having access to excess reserves — is very high," Petrou said. "Secondly, one of the reasons excess reserves are as high as they are … is because banks have no place else to put the money. Some of that is the capital rules and the liquidity rules … and some of it is that the economy remains in very modest recovery, and there's not a lot of loan demand."