The last few years has witnessed a rising tide of academic studies that have concluded that financial systems in advanced economies like the US have become outsized and are a drag on growth. One of the most recent and particularly devastating pieces came out of the IMF. That study found that Poland’s banking system was at the optimal level of product sophistication and penetration.
Since the financial services industry also so heavily subsidized that it should not properly be considered private enterprise, these articles are an indictment of how the sector operates. Banks should be regulated like utilities, or at least have their subsidies greatly reduced.
Yet the Fed is firmly against taking even mild steps to rein in hypertrophied banks, and no less that Janet Yellen herself acting as subsidy-shill-in-chief.
Budgeteers have woken up to the fact that banks get a difficult-to-justify perk from membership in the Federal Reserve system, that of getting 6% annual dividend on the preferred stock that they bought at the time they joined. A draft bill by Senate Majority leader Mitch McConnell includes a provision that would cut the dividends to member banks with more than $1 billion in assets from 6% to 1.5%. He’s proposing to use it to help shore up the highway trust fund.
The Wall Street Journal describes how the banks are really unhappy about this plan. Mind you, the sense of entitlement is on full display, as usual. Banks treat any potential encroachment on their “heads I win, tails you lose” arrangement they have with the general public as an outrage that must be beaten back. Mind you, the amount that this change would raise is all of $16 billion over three years. Do the math. This is hardly enough at any one bank to cover a single decent-sized fine. But rather than clean up their conduct, they’d rather fight to keep all the banking perks. Yet note the inability to identify a single institution that would suffer harm:
Although the dividend reduction wouldn’t be a major hit to any one bank, the total annual decrease is equal to roughly 4% of industry profits, said Jaret Seiberg, an analyst with Guggenheim Securities LLC.
The best quotes industry defenders could give to the Journal were vague threats, that the provision would lower liquidity, weaken banks (how, exactly?) and “hurt financial stability”. Since the banking industry needs to become smaller, forcing some of them to abandon businesses is an outcome sorely to be wished. But banksters like to depict any actual or potential impairment of profits and cashflow as a threat to the institution, rather than a threat to executive and producer bonuses and bank dividends.
But Fed chairman Janet Yellen did her turn as a bank lobbyist. She can’t take up the claim that this change would increase systemic risks, since the central bank runs stress tests on the biggest institutions and can simply require any that might fall short to lower their dividends to strengthen their capital levels. Instead, she throws out the strained argument that cutting this subsidy would hurt the Federal Reserve system. Again from the Journal:
Fed Chairwoman Janet Yellen last week said she was concerned such a proposal could reduce banks’ willingness to be part of the Federal Reserve System and might pose a particular challenge to smaller banks that rely on the dividend.
“This is a change to the law that could conceivably have unintended consequences,” Ms. Yellen said while testifying before the Senate Banking Committee on Thursday. “And I think it deserves some serious thought and analysis.”
This is hogwash. Any bank that left the Federal Reserve system would lose access to Fedwire. Back in the age of stone knives and bearskins, as in the mid-1980s, Sumitomo Bank looked into the cost of giving up its US banking license to make a securities firm acquisition. It was a non-starter due to the cost of losing access to Fedwire. If a foreign bank couldn’t contemplate doing it in an era when electronic interbank settlements were a fraction of what they are now, there’s no way that any reasonable sized bank could consider it now. Indeed, the existence of Fewdire alone demonstrates why the idea that the Fed pays banks at all is so barmy. As Perry Merhling points out, the various interbank payments systems could not exist but for the existence of a central bank backstop. Banks run large intra-day balances between each other during the day and settle up their dollar balances at the end of the day on Fedwire. The existence of that service in and of itself is a support to the banking system.
Moreover, there’s no upside to leaving the Federal Reserve system. Banks have to adhere to the Fed’s reserve requirements whether or not they are members of the Federal Reserve System. That became law in the Depository Institutions Deregulation and Monetary Control Act of 1980. This write-up from the Dallas Fed explains how all depositary institions must comply with the then new law:
Title I of the act is known as the Monetary Control Act of 1980. It required all institutions that accepted deposits (“depository institutions”) to meet reserve requirements. Reserve requirements are an important tool the Fed can use to achieve desired changes in the money supply. Up until this time, only commercial banks that were members of the Federal Reserve System were required to hold reserves, and by 1980 less than 40 percent of banks were members. Other depository institutions, such as savings and loans and credit unions, whose deposits are also part of the money supply, were not subject to the Fed’s reserve requirements. This was limiting the Fed’s ability to control the money supply.
Reserve requirements mandate that depository institutions set aside a certain amount of their funds either in the form of vault cash or the accounts they keep at regional Federal Reserve Banks. The amount they have to keep in reserve is based on the size of their deposits.
The good news in the Wall Street Journal story is that the idea of whacking Fed dividends, is now on the informal list of “pay fors,” as in place where parties looking for funding for bills can find it when they need it. So the 6% dividends for all but small banks is doomed even if it managed to survive the highway trust fund fight. And other ideas that would have the effect of cutting the banking industry down a tad have also been mooted:
Proposals to ding banks as a way to offset spending aren’t new. The banking industry lobbied furiously last year against a budget bill from then Rep. Dave Camp (R., Mich.), who proposed a new tax on the biggest banks as a way to generate revenue. Although the Camp bill never gained traction, industry executives warned at the time it would set a dangerous precedent and be more likely to emerge in future budget debates.
“The problem is this is going to keep coming up now,” Mr. Seiberg said of the dividend proposal. “This has been elevated and it’s going to become one of those low-hanging fruit pay-fors that’s going to surface with every spending bill.”
And even though these two proposal were put forward by Republicans, the Fed dividend cut proposal originated with the Progressive Caucus, showing that elements of the right and left are starting to form a Main Street alliance against Wall Street.
But there’s no doubt as to where Yellen stands. By making an argument over the pay grade of most journalists and members of the great unwashed public, she hopes to snow them into supporting, or at least not opposing, a bank subsidy well past its sell by date.