WASHINGTON — A measure that would substantially cut the Federal Reserve's dividend payment to member banks is likely to prove difficult to remove from a Senate highway funding bill even though it has few public backers and many critics.
The provision, which is expected to resurface when Congress reconvenes next week, would slash the dividend that the central bank pays to member banks to 1.5% from 6% for institutions with more than $1 billion of assets.
Banks, regulators, and even members of the House and Senate banking committees oppose the measure, but no vocal supporters have emerged to promote it.
"This has been an effort that no one has taken responsibility for," said James Ballentine, executive vice president of congressional relations and political affairs at the American Bankers Association. "We're not really sure who the father is of this child, but we hope it can … go away as quickly as it came up."
That may be much harder to do than it looks. The provision, which is expected to raise $1.7 billion per year, is being used to offset the cost of the highway transportation bill, making it exceptionally attractive to lawmakers.
Though no one is taking credit for the idea, some said that dividend, which is paid to banks to offset the cost of becoming a Fed member, is an outdated idea.
"Large financial institutions have an incentive to participate in the Fed system, and we saw the dividend as an unnecessary and wasteful subsidy," said a Democratic staffer who spoke on condition of anonymity.
The idea of generating revenue by slashing the Fed dividend first appeared in 2014 in an alternative budget proposal put forward by the Congressional Progressive Caucus.
But few other groups have come out in support. No member of Congress in either chamber has spoken out in favor, though Sen. Jon Tester, D-Mont., suggested he might favor the measure if the provision only affected banks with more than $10 billion of assets, thus covering fewer community banks.
Opponents, meanwhile, have been diverse and vocal in their opposition. Senate Banking Committee Chairman Richard Shelby, R-Ala., called paying for highways with Federal Reserve dividend funds a "far reach," while Fed Chair Janet Yellen said the proposal "could have unintended consequences for banks' willingness to be part of the Federal Reserve system, and this might particularly apply to smaller institutions."
During a July vote in the House Financial Services Committee, Rep. Carolyn Maloney, D-N.Y., offered an amendment — later withdrawn — that would have required a study of the effects of the dividend change, saying that the Senate Environment and Public Works Committee that drafted the highway bill "chose 1.5% based on how much money they needed to pay for" the legislation.
Rep. Bill Huizenga, R-Mich., who chairs the committee's subcommittee on monetary policy and trade, said he would work to arrange a hearing on the issue when Congress reconvenes, saying that the haphazard and clandestine manner in which it was introduced is underhanded and the matter deserves closer scrutiny. The committee has not yet scheduled a hearing on the issue.
"From a process standpoint, this is extremely troubling to me and many others," Huizenga said. "I'm not aware of any fulsome debate or discussion in recent history regarding the ownership structure of the Federal Reserve Banks, and further we should always be wary of changing a 100-year-old structure in an effort to simply pay for something else."
But there is a widely held expectation among the measure's opponents that the provision will eventually become law, if not necessarily through the highway bill then some other spending bill down the road. That's because the dividend is a previously untouched pool of cash, and in an era where ends are increasingly being met in spending bills through accounting tricks or other legislative shenanigans, a resource like that simply won't go untapped.
"It's not like the budget gimmickry that we've done the last few times, like pension smoothing," said Isaac Boltansky, an analyst with Compass Point Research & Trading. "I think the current budgetary realities, coupled with the potential for this measure to be more narrowly focused by increasing the applicable asset threshold, my sense is that this provision will eventually become law."
Ballentine agreed, saying that once a budgetary resource is discovered, it can't be unseen.
"Whenever pay-fors have been identified, they never seem to go away — they seem to be temporarily put on hold," Ballentine said. "We hope that's not the case with this particular proposal, because in its true sense, when you make this kind of change … without any analysis from the committee of jurisdiction, it becomes problematic. It doesn't set the best precedent, but also from a policy standpoint, it doesn't seem to make much rational sense."
The Federal Reserve System was established as a hybrid public-private entity that was designed to take monetary policy issues out of the hands of political actors and put them into the hands of independent financial professionals. But that independent regulator would have failed without sufficient buy-in from the existing banking system, so the Federal Reserve Act required banks that wanted to be members to buy stock in the system.
That stock cannot be sold or transmitted and has essentially no value except as a means of accessing the Fed system. Banks have to buy 50% of their full stake in the system upon joining, but they have to keep enough cash reserves to buy the remaining 50% in perpetuity, and that stake is set at 6% of total assets. So, in effect, 3% of total assets are spent buying stock with no market value and 3% of total assets has to be held in reserve, in cash.
To offset the cost of keeping that much capital tied up, the Fed pays out a 6% return on the banks' stock — a level that is set in the authorizing statute, not by the Fed itself. Nationally chartered banks are required to be Fed members, so reducing their interest rate would not affect their membership. But state-chartered banks who are Fed members by choice might find the arrangement less attractive, according to Karen Shaw Petrou, managing partner at Federal Financial Analytics.
Petrou said that, aside from the dangers associated with possibly reducing the pool of Fed member banks, there is also a risk in setting a precedent that the central bank is a potentially lucrative source of budget carve-outs that cumulatively could have far more drastic consequences.
"It has a modest effect in the near-term," Petrou said. "I think it has a much more significant effect … in that it is opening up the Fed's balance sheet to the appropriations process. That's the challenge."
Aaron Klein, a former Treasury official and Hill staffer who now heads the Bipartisan Policy Center, said that the precedent is particularly troubling with respect to the Fed's intention to pay dividends to banks' excess reserves. That is supposed to be a key tool for the Fed to raise short-term interest rates when it goes forward with its much-vaunted interest rate "liftoff," which is expected sometime later this year. But if Congress starts siphoning off those dividends to stop up holes in its budget, that could make the tool far less effective, Klein said.
"I'm very worried about the precedent that … once the Fed starts payments on excess reserves … what's to stop Congress from trying to change that interest rate to offset short-term spending?" Klein said. "The Federal Reserve should not be a piggy bank for Congress."
Boltansky said that so long as the drive for the change was coming from a budgetary perspective and not an ideological one — as opposed to, say, the move by Sens. Elizabeth Warren, D-Mass., and David Vitter, R-La., to curb the Fed's emergency lending powers or Sen. Rand Paul, R-Ky., to "audit the Fed" — the proponents will be waiting in the wings rather than pushing publicly for the change. That way their preferred legislation gets funded and their hands are clean of any blowback that falls on small or mid-sized community banks in their district.
"Even though the largest banks would be the most negatively impacted by this provision, some regional and community banks will be hurt as well," Boltansky said. "There are two things in nearly every congressional district: a community bank and an auto dealer. I think Congress will ultimately need this budgetary offset but it's not politically prudent for politicians to pound the table in support of the measure."
Bankers are already brainstorming of ways to block the move. In the short term, many expect that even if the House does not include the provision in its version of the Highway Bill, it could come up in reconciliation — when representatives of the House and Senate meet behind closed doors to decide what measures of their respective bills to include in a unified legislation. That process will probably not resolve until later in the fall or early winter.
In the longer term, bankers are talking about changes to the Fed dividend payment system that might be acceptable to both Congress and bankers. Those fall broadly into two categories — ways to make the dividend payment work and ways to make the stock ownership arrangement more palatable if the dividend payments are lowered.
One option would be to float the dividend payment, tied to some market-based interest rate or index, so that it is not a burden in high interest rate environments or a windfall in low-rate periods. Another would be to eliminate the dividend altogether, tying Fed membership to some other mechanism besides stock ownership. Still another possibility would be to change the 50/50 stock-to-reserve-cash ratio to some other ratio that reduces the burden of keeping 3% cash on hand at all times.
Banking groups said there are no immediate, firm plans to commission studies of the issue or to identify possible policy recommendations besides defeating the provision in the Transportation Bill.
And banking groups appear unified in that respect. Paul Merski, executive vice president of congressional relations at the Independent Community Bankers of America, said that even if a provision were passed that raised the threshold to $10 billion — thus exempting most community banks — the ICBA would still oppose it "on principle."
"We remain completely opposed to using the community banking sector as a pay-for for legislation, particularly with no analysis, no debate," Merski said. "You're really going to run into a situation where banks are going to be forced to drop out of Federal Reserve membership and no one has analyzed what chaos that may cause."