McClatchy: Fed Interest Earnings Approach $100 Billion
Fed’s interest earnings approach $100b
WASHINGTON — The Federal Reserve said Friday it transferred a record $96.9 billion to the U.S. treasury in 2014, profits on its unprecedented $4.4 trillion in holdings designed to support the U.S. economy in the aftermath of the Great Recession.
Returning to a topic I have raised a few times here at Angry Bear: what is the real cost of financing U.S. Public Debt. Also interesting from the perspective of the repeated desire from the Right to “Audit the Fed”. More from the McClatchy piece:
The Fed’s total assets were $4.5 trillion last year and its holdings generated $115.9 billion in interest income, the central bank said Friday, and that reflected an increase of $25.5 billion from 2013. The Fed also paid banks $6.9 billion in interest income for their balances held at Federal Reserve district banks last year.
The independent Fed, which does not rely on Congress for funding, had operating expenses of $6.1 billion in 2014. This number included $1.9 billion to run the Federal Reserve Board, currency costs and operation of the Consumer Financial Protection Bureau, created in the 2010 revamp of financial regulation.
Lots to unpack here and plenty of directions to take the discussion. So rather than noodle on by focusing on my own preoccupations let me turn this over to AB readers. As a Federal Reserve/Public Debt/Quantitative Easing/CFPB Open Thread.
Update: Link to Fed’s Audit Report (h/t McClatchy) Board of Governors of the Federal Reserve System; Financial Statements as of and for the Years Ended December 31, 2014 and 2013, and Independent Auditors’Report
The Fed has a gross leverage ratio (Total Assets:Total Capital) of about 80x. http://www.federalreserve.gov/monetarypolicy/bsd-overview-201411.htm
For reference, in 2008 Bear Stearns was levered around 34x, Lehman Bros was levered around 24x, Fannie Mae was levered around 21x, and AIG was levered around 14x.
M Jed in looking over that Asset and Liability statement and seeing that on the Liability side are all Federal Reserve Notes in circulation plus all bank reserves it would seem that the Feds normal leverage ratio would be negative. After all that would seem to be the essense of Federal Reserve Notes being ‘fiat’ currency, that is ostensible money backed only by Full Faith and Credit. From that perspective it is rather miraculous that the Balance Sheet shows a postive balance at all.
As to comparing the Fed to Investment Banks it would seem that the role of Capital is much different. Because whether examined from the MMT perspective or even from Goldbugs the effective capital of the Fed is actually infinite. Because they own the money machine.
Not only that but in re-examining that sheet it would appear that the goal of the Fed would seem to be to keep their capital balance at near zero anyway, otherwise they would simply retain profit as ‘retained earnings’ rather than rebate it to Treasury. So frankly I am missing your point here. Why would the Fed WANT a higher capital ratio? Because neither liquidity or credit seems to be an issue for it. And why else would capital ratio matter?
That’s about 1.5% of GDP! Impressive. My guess is that it’s less than 0.5% of GDP in normal times.
As a rough rule of thumb, seigniorage revenue (the central bank’s annual profits) as a % of GDP will be given by:
(currency/GDP)x(nominal interest rate)
We should subtract this amount from the cost of servicing the debt, but it should make no difference **at the margin** to debt service costs.
Bruce: the only difference that the Fed’s “capital” (or having any assets at all) makes is that it helps keep it independent from the rest of government, in the event that it needs to do a very large open market sale of bonds to prevent inflation rising above target, and runs out of bonds to sell. But even here it could, in principle, borrow against its future seigniorage revenue, or else raise interest rates on reserves (which amounts to the same thing).
Yep, it’s not like a commercial bank, because Fed notes are not IOU’s. But it does have an inflation target, so *might* need to buy back its notes to prevent inflation rising above target.
Nick you might need to explain “**at the margin**” to me. Because certainly politicians use “net interest” and its prospect for crowding out other spending as a scare tactic and DO NOT net out interest paid to the Fed.
Also if you look at the Tables and Figures referenced “capital” is NOT included under “assets” but instead is included with “liabilities” on the OTHER side of the balance sheet. As such it falls into the same slot that on a business balance sheet as would be “retained earnings” and/or “owners’ equity”. So from an accounting standpoint I have some issue with your first sentence.
$97B is a huge number, but the balance sheet is gigantic.
What’s the net interest spread? 2.16% is the net margin earned this year.
What happens if interest do rise off zero? The Fed earnings will be smaller. How high will interest rates go in the next few years? Who knows the answer to that. I will defer to some experts on this topic – who better than the Fed to rely on for a forecast?
The ‘central tendency’ of the projections are for a range for Fed Funds between 3-4% for 2016 and solidly at 4% in 2017.
In other words, rates will rise by 3.5%+. What will this do to the Fed’s income statement? It will fall to close to zero.
The reward today for the big balance sheet will turn to a liability in just a few years. I don’t see the Fed’s big income in 2014 to be a positive thing, it is a measure of how much risk the Fed has taken on.
Note: The outlook for the Fed is dimmer if one were to use either CBO’s or SSA’s numbers for future interest rates to assess future Fed earnings.
The Fed data (page 3):
http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20140917.pdf
Does this defer the day of reckoning on the debt ceiling… Or has it already been factored in?
i would think factored in. Not a surprise to Treasury who both issued the interest payment and ‘cashed’ the rebate from the Fed.
Krasting the Feds return is based on coupon on existing bonds. Increasing interest rates might drive down price on existing bonds but the Fed has no need to sell, its earnings instead will be driven by coupon rates. How do their earnings drop? Like the Soc Sec Trust Fund the holdings of the Fed are not like a standard bond fund. Something that you can’t seem to grasp.
Krasting I should have used “earnings” rather than “return” because as you pointed out/claimed the Fed did buy some of these over par. Still whatever they paid and so how limited the actual return (as conventionally measured by the market) their actual earnings are driven entirely by coupon rate.
Webb – The fed has $2.4T of floating rate liabilities. These are the excess reserves. The fed currently pays banks 0.25% on these deposits. This is IOER. IOER = Federal Funds.
The $6.9B of interest expense reported by the fed is $2.5T*IOER. What happens to the Fed if IOER goes to 4%? Then $2.5T*4% = $100b.
So if/when interest rates rise the Fed will HAVE to borrow money at higher rates. As it incurs higher interest cost its net income will decline. If rates do get to 4%, the the Fed would have negligible annual income.
Note: The Fed does not have to sell a bond to incur a loss, it just has to raise the interest rate that it pays for borrowed money.
Follows a link to FRB St Louis with a chart on excess reserves at the Fed. Also is a link from the Economist that explains how the Fed could lose money, or earn very little.
The Fed owns long-term fixed income bonds. Its income will not vary as the yields are locked in. But the cost of borrowing to finance the assets will almost certainly rise over the next 24 months.
https://research.stlouisfed.org/fred2/series/EXCSRESNS
http://www.economist.com/news/finance-and-economics/21570753-what-happens-when-fed-starts-losing-money-other-side-qe
IOER is not the same thing as the federal funds rate. The Federal Funds rate is the rate banks charge each other when they borrow reserves from each other. They just happen both to be almost exactly zero. Until 2008 IOER < the federal funds rate.
In 1982 IEOR was 0.00% The Federal funds rate reached 19.1 %.
The Fed is not required to pay interest on reserves, and never used to pay interest on reserves. It was a Benanke fed innovation, basically a way to bail out banks without dealing with Congress.
Typically high intererest rates imply high Fed profits as it receives interest but doesn't pay interest. If the Fed had stuck with its September 1 2008 portfolio, it's profits would have declined compared to normal and would be around zero.
Now it is true that the Fed plans to cause a higher Federal funds rate by paying higher interest on reserves. This is a completely new policy — it has never paid more than 0.25% before. Nothing forces the Fed to do this.
The effect will be higher interest rates generally. The Fed will also earn higher returns on new bonds it buys as its old bonds mature. The market value of its holdings will decline. If it marked to market
Finally the E in IOER is excess which means above the reserve requirement set by the Fed. The Fed can reduce excess reserves at will by raising the reserve requirement. The Fed can increase the interest rate they pay on excess reserves to 2.5% per year without paying more than the current $ 6.9 billion a year by making 90% of currently excess reserves into required reserves. They won't do this, but they can do this any time they choose.
Robert – You say:
“Now it is true that the Fed plans to cause a higher Federal funds rate by paying higher interest on reserves. ”
So you agree with what I said. As the Fed Funds rate rises, so will IOER.
The Fed HAS TO borrow money to fund it portfolio. (Yes?)
You say that the Fed could solve the problem by redefining excess reserves as required reserves. I agree with you when you say “They won’t do this”.
Understand that a 90% reserve requirement would destroy the concept of fractional reserves that the banking system and the economy rely on. So this idea is not a realistic outcome. The Fed would not shoot itself in the foot in this manner. It would run totally contrary to their mandates of maximizing employment while maintaining stable prices.
Krasting WHY would the Fed ever have to borrow money to fund its portfolio? After all it went through 3 rounds of QE using money from its own printing press to BUILD that portfolio. And near as I can see has no actual carrying charges to fund.
The Fed is sitting on assets that pay some $116 billion in interest each year. It has operating expenses of $6.1 billion and more or less of its free will pays $6.5 billion in interest on reserves (which as Robert notes is something new). Which is why it had close to $100 billion left over to rebate to Treasury.
If the Fed does nothing it will still collect something close to that $115 billion a year for most or all the next ten years and could if it wish just stop paying that 0.25% on reserves and so save another $6.5 billion a year. So exactly what would cause it to have to borrow money for anything at all?
Maybe you are right but as usual you just throw this stuff out as it it were obvious. Well it isn’t obvious and given your track record of being wrong on lots of stuff it is incumbant on you to explain this at some length. When you say:
“The Fed HAS TO borrow money to fund it portfolio. (Yes?)”
And I say “Well No” can you explain why I am wrong? Because God knows I have spent enough time explaining in detail why I believe you are wrong.
Under what circumstances and via what instrument would the Fed EVER have to borrow money? Because on my reading of the account linked from McClatchy almost all their current liabilities consist of what goldbugs would insist is ‘fiat money’. They own the printing press why on earth would they have to borrow anything?
Pretend I am slow, some intern in your former bond firm, and just spell it out. If you can.
So $100 billion of deficit reduction is due to the de facto financing of federal expenditures through creating money, instead of borrowing or taxation. Providing it doesn’t lead to financial disruptions (inflation), and there is no evidence it has or will, shouldn’t do more of it?
Webb – You ask:
“Under what circumstances and via what instrument would the Fed EVER have to borrow money?”
The Fed is borrowing 2.4T today. The deposits that are on the balance sheets are Liabilities. The same pattern exited in 2009-2013. The Fed will continue to borrow money in 2015 and well beyond.
This is accounting 101. The Fed has assets AND liabilities. Some of those liabilities have a floating rate cost. If and when % rates rise the Fed will face higher borrowing costs.
You do get the connection between the $2.5T and the $7b in interest, yes? So if the Fed is paying interest today what is it paying that interest on? The deposits! You seem to think that the Fed does not have liabilities and that it does not pay interest on those liabilities. That is not correct.
Webb – The CBO estimates the Fed’s contribution to the budget in future years. As you know, the CBO believes that % rates will normalize over the coming years. CBO had this to say about future Fed earnings based on the rising rate forecast:
Remittances of the Federal Reserve are expected to fall
from 0.6 percent of GDP this year—their highest level in
history—to below 0.2 percent of GDP by 2024.
Page 23 0f the report:
https://www.cbo.gov/sites/default/files/45653-OutlookUpdate_2014_Aug.pdf
Would someone explain how the fed, which is owned by the stock holders and guaranteed by law which may not be changed 6% on deposited assets. Then the stock holders of the fed buy bonds or treasury which also earn interest can ever not be making a profit.
Krasting I went back to college in 2013 and took a three semester sequence in Financial, Managerial and Computerized Accounting. Exactly how long ago was your course in Econ 101 and really how much Accounting did it cover? Because you seem shaky on the basic concept of ‘Liability’,
Take a look at the link supplied by M.Jed.
http://www.federalreserve.gov/monetarypolicy/bsd-overview-201411.htm#sthash.aBWCZnSp.dpuf
It shows the Fed with a total of $4.4 trillion in ‘liabiilities’ of which $1.2 trillion are “Federal Reserve Notes in Circulation”. Step back for a second. Did the Fed have to BORROW from anyone before issuing those Notes? No it did not. It just issued them as ‘fiat money’. Does it pay interest on those Federal Reserve Notes? Well no it doesn’t. Is it obligated to buy every dollar in circulation back at some point in the future? Not at all. Why then do they score a ‘liabilities’. Because they exist as actual stores of value based simply on the ability of the Fed to issue them back by Full Faith and Credit of the U.S. And if for some reason Congress decided to eliminate the Federal Reserve (as it did with its long ago predessessors the First and Second Banks of the United States http://en.wikipedia.org/wiki/Second_Bank_of_the_United_States) it would be incumbent on the Treasury to redeem those Federal Reserve Note with Treasury Notes. (And if Ron Paul got his way presumedly with old fashioned Gold Certificates). Meaning that every $20 bill in your wallet is a liability in the sense that it would be an obligation on the part of the Fed in case it was unwound. Which doesn’t mean that it was ‘borrowed’.
And the same I submit is true of Bank reserves. Banks are required to hold reserves which are either Federal Reserve Notes or perhaps full equivalents in the form of Treasury Bills and perhaps Notes. Per the balance sheet above those deposits total $2.6 trillion. I don’t see that those funds were in any sense ‘borrowed’ by the Fed. Instead Banks were simply required to hold a certain category of asset issued by the Fed or Treasury. Now obviously these assets are a claim on the Fed and are carried as ‘liabiities’ on the Fed’s balance sheet. And in the remote in the extreme case of the Fed being abolished come successor agency or Bank would have to take them on as liabilities on their own balance sheet, to that degree they are a ‘debt’ ‘owed’ to the Banks. But it is frankly absurd to assert that this means the various Federal Reserve Banks and member banks ‘borrowed’ the money from the Fed. Even though the Fed has chosen to pay a nominal amount of interest on the funds. And it is even more absurd to think that the Fedsomehow ‘borrowed’ the money which it is requiring those banks to hold. After all those funds could be (but mostly probably are not) simply stacks of Benjamins merrily printed by the government on behalf of the Fed. Let me stop here and discuss the Economist article in the next comment. Because while it superficially supports your claims at the outset it undercuts them by the end.
The Economist article cited by Krasting starts with an ominous title:
“The other side of QE: What happens when the Fed starts losing money”
The article sets the stage:
“The Fed’s liabilities are principally made up of currency in circulation, which pays no interest, and reserves, the cash that commercial banks keep on deposit at the Fed. Since 2008 these reserves have exploded to $1.6 trillion, on which the central bank pays only 0.25% interest. The difference between that modest cost and the average return of about 3.5% on its bond holdings explains the whopping “seigniorage”, as the profit the Fed earns from printing money is called.”
Okay so far so good. But look at the assumption slipped into the next piece:
“Since 2008 the Fed has paid interest on reserves in order to maintain control of interest rates. So when the Fed eventually tightens monetary policy, it will have to pay out more interest. To absorb reserves it may have to sell some bonds for less than what it paid, incurring capital losses. In theory, it could end up losing money, a risk that grows the more bonds it buys.”
Why would the Fed “have to pay out more interest”? Why couldn’t it simpy revert to the pre-2008 policy of not paying interest on reserves? The authors don’t say. Which doesn’t mean there is a reason, just that neither they or certainly Krasting supplies it. And if that interest requirement goes away so then does the idea that the Fed can be forced to sell bonds at a loss to pay for it.
Having skipped over this point the authors go on to say:
“For the government as a whole, these losses are less than meets the eye.”
To which I say “Boy Howdy!” Because it turns out that these losses are simply paper losses, they only show up on balance sheets and don’t result in any cash flow requirement:
“Whether such concerns would really blow the Fed off the course dictated by economic circumstances is debatable, however. The Fed would not actually need a taxpayer infusion. One of the perks of central banking is that it can print the money needed to pay interest. If that generates a loss, it creates an offsetting “deferred asset” on its balance-sheet, representing future profits it won’t have to send to the Treasury.”
I am still not seeing how this balance sheet loss, which would simply reduce current rebates to Treasury or preclude future rebates to Treasury, in any way requires or results in ‘borrowing’. Because as the Economist authors admit there is no eed for a “cash infusion”.
Beene I don’t understand your question. Either there are some missing parts or I am too dim to unpack it. At a minimum there are some grammar errors in both sentences as they stand. Sorry, I don’t mean to dodge it, I just don’t get it.
Krasting as for the following I just don’t see the import:
“Remittances of the Federal Reserve are expected to fall from 0.6 percent of GDP this year—their highest level in history—to below 0.2 percent of GDP by 2024.”
Well yes and I addressed that at least implicitly:
“If the Fed does nothing it will still collect something close to that $115 billion a year for most or all the next ten years”
Certainly there will be some drop in the nominal amount of interest earned on Fed holdings of Bonds as those 10 and 30 years mature, I didn’t stop to try to calculate the magnitude and have no reason to doubt that it equates to a drop from 0.6% of GDP down to 0.2%. On the other hand a 66% reduction in that amount as a percentage of GDP does not equate to a 66% reduction in nominal dollars. Because GDP is projected to increase over that time and so increase the denominator. Either way that CBO number reports that the Fed will STILL be rebating money to Treasury over the next ten years. And it would seem to me still in amounts greatly in excess of any interest being paid on reserves.
In this light it is important to note that the Economist article was written in Jan 2013 and projected tightening starting in 2014. As such we can’t really take its 2017 projection for profits turning to losses at face value. Remembering that these are only paper losses and that assuming the Fed keeps paying interest on reserves.
Clarifying my 11:25
Since member banks are required to hold their reserves on deposit with the Fed (as opposed to having them in some bank vault somewhere) they clearly are not “borrowing” those funds from the Fed but are instead being required to make a forced loan. But this is rather a stretched sense of the word “borrowing” as regards the Fed against the banks in question. I mean is my landlord “borrowing” my damage deposit and last months rent when they require me to remit it up front?
Well sorta. But this doesn’t make them some sort of desperate debtor.
Bruce Webb, thanks for the effort.
My high school English teacher is finally getting her revenge; as now I want to write sometimes. 🙁
Webb – you say:
this doesn’t make them some sort of desperate debtor
I never said they were a desperate debtor. Far from it. The Fed has the best credit rating in the world. It can borrow any amount that it wants, at any time that it wants.
The Fed’s liabilities are (primarily) Equity, Seignorage and Borrowed Reserves. There is no cost to the printed money nor the equity. But there is a cost of the reserves that it borrows. Today that cost is .25%.
There are two ways that the Fed could have lower profits (or a loss) in future years.
1) They sell some bonds from portfolio and they suffer a loss. We agree that this not at all a reasonable scenario. So let’s just forget about this.
2) The amount of annual interest they pay on borrowed reserves rises. This is what will happen (if you believe the current words from the Fed).
The following is from a Fed link. The sentence does cover both 1 and 2 above. Again, #1 (losses from securities sales) won’t happen but #2 higher borrowing costs will.
“the projections imply that remittances to the Treasury continue at a robust pace through 2015. However, when the federal funds rate increases and securities sales commence, remittances might be halted for a few years, reflecting the elevated interest expense on reserve balances and capital losses associated with sales of MBS, both of which offset the interest income from the portfolio.”
This is a fairly old report so it does not have the current balances sheet info, but I think it does explain how this works. The report was written by Seth Carpenter. I have communicated with him several times in the past. He is a very nice guy and I am sure he would respond to you. I will send you his email in a private note.
http://www.federalreserve.gov/pubs/feds/2013/201301/
I can’t do more than that to convince you that the Fed does borrow, and it does so at a floating cost, and that cost is projected to increase. But I will take some screen saves of these comments, and we can rehash this in a few years when the results are published.
Krasting thanks for the link. It made for fascinating, if dense, reading and I will have to revisit it.
Having said that much of your comment still doesn’t make sense.
1) How are you defining ‘Equity’? This doesn’t seem to be used in the paper you link. Can you cite a particular section?
2) How can ‘seignorage’ be considered a liability? That makes no sense at all.
3) nothing in any of this supports a claim that the Fed ‘borrows’. In reading through the link there is the statement that under certain conditions a combination of increased interest payments on bank reserves and realized loses on MBS’s might for a SHORT PERIOD offset interest earnings on the SOMA assets and so result in a halt in remittances to Treasury. But none of that entails ‘borrowing’.
So no what you have supplied does NOT “explain how this works”.
This is particularly true since you deny that there will sales of bonds from the portfolio “So let’s just forgt about this” yet your quote from Carpenter’s report explicitly projects “sales of MBS” with “capital losses associated”. Now we can retrieve this somewhat by acknowledging, as all three of me, you and Carpenter do, that there will be no sale of Treasury securities. But still it is clear that any pause in remittances can ONLY be caused by booked capital losses on MBS’s and not from interest expense on reserve balances. Because existing seignorage on the much larger SOMA Treasury holdings balance and the interest paid on reserves cannot (it seems to me) totally offset. Perhaps your can cite the passage in Carpenter’s report that shows otherwise.
The reason you can’t convince me that the Fed does borrow is that you didn’t really try. Instead you threw around terms like ‘seignorage’ which didn’t make sense in context and refer me to a lengthy paper which you blandly assure me supports your argument, but without actually citing any particular piece that does.
As a parting shot it is worth noting that this Report explicitly takes the Blue Chip forecast on interest rates and denies that those are actual Fed projections so it really isn’t a Fed thing at all.
Maybe someone else can chime in here and translate your assertions into some argument that makes sense. God I hope so.
The Fed does not borrow. Period. I may be totally wrong about that but nothing you have presented convinces me in the slightest. All I see is you sliding from ‘liability’ and ‘capital loss’ to ‘borrowing’. Well that doesn’t follow, not at least along the track you trace.
Webb – Okay, didn’t expect to turn you away from where you’re sitting. Possibly Carpenter can do that.
I do ask you to think this through one more time and focus on the $6.9B of interest the Fed reported paying last year. To have paid interest it confirms that some money was borrowed (in the form of deposits). You do see that right? Interest was paid, so what was it paid for? It was to pay for the $2.4T of deposits.
Do you think the Fed’s interest payments on the deposits will fall this year and next? I think it will remain the same or be higher based on the timing and magnitude of the increase in Fed Funds/IOER.
In two years this will all be in the published numbers. Maybe then you’ll come to accept this. Should I see something recent and credible on this topic I’ll send it your way.
Krasting we are at an impass here.
I see a requirement by the Fed for banks to deposit funds at the Fed at an interest rate determined by the Fed that before 2008 was 0.0% and today is 0.25%. In turn the banks get access to various Fed facilities like the Discount Window. To the degree than banks could get a better return than 0.0% (then) or 0.25% (now) this requirement works for like a fee for service than a forced loan.
Okay you want to see this forced loan from the banks as a form of borrowing by the Fed. Alright a stretch but hey there is interest paid.
But your opening move in this argument was this:
“So if/when interest rates rise the Fed will HAVE to borrow money at higher rates. As it incurs higher interest cost its net income will decline. If rates do get to 4%, the the Fed would have negligible annual income.”
I didn’t see anything then or in the course of the argument sense that suggested that the “FED will HAVE to borrow money at higher rates”. Because the Fed sets those rates at will and used to have them set at a whopping 0.0%. Now maybe there is a mechanism that will FORCE the Fed to pay a higher rate than 0.25% on bank reserves. For the life of me I can’t see what that would be. You seem to believe that a higher Federal funds rate automatically translates into a higher IEOR. But why? Particularly considering the following point brought up by Robert above (10:33 PM)
“In 1982 IEOR was 0.00% The Federal funds rate reached 19.1 %.”
To which your ‘response’ was (11:30 PM)
“As the Fed Funds rate rises, so will IOER.”
This follows HOW? And yes I recognize that Robert suggesedt that the IOER would incease because of a deliberate policy decision by the Fed. But somehow you tranlsated that “would” into a “must” when that doesn’t follow at all. Because obviously there is no inherent connexion there given a history of 19.1% Fed Funds and 0.0% IEOR.
Bit of history. In March of 2008 Bears Sterns got an emergency $25b loan from the NY Fed. That was the tip of the iceberg that was coming. The markets calmed after the Fed acted. But the Fed must have know that trouble was brewing. So it asked Congress to change the rules and allow for the payment of interest on reserves. Read through this article by IP (very knowledgeable guy). He totally missed what the Fed was planning on doing. The payment of % on reserves is a necessary requirement for QE.
Then the SHTF and in October Congress granted the Fed the right to pay interest on reserves. QE 1 followed soon after.
My point is that whatever may have been the historical relationship of IOER and Federal Funds was broken when the rules were changed in 2008. These eggs a scrambled now, they can’t go back in the shells. You have to look forward with what is on the plate, not look backward at something that no longer exists.
The WSJ article from long ago:
http://www.wsj.com/articles/SB121011673771072231
Krasting nothing in what you say here suggests that the IOER needs to go up in proportion to the Fed Funds rate.
Yes the Fed CAN pay interest. But what says that they MUST pay interest or that that interest MUST go up commensurate with increases in the Funds rate? You have introduced nothing new here.
The WSJ article is behind a paywall and I will have to take a pass.
Webb – I don’t think this Bloomberg story has all the answers to resolve our debate. But it does give some insights of what may/will happen. This quote suggests that IOER will rise along with the Federal Funds rate when the Fed does tighten policy. This is my expectation as well. We shall see soon enough!
“Strategists have expressed concern that, when the Fed starts to tighten policy by raising IOER, other market rates may not follow, leaving monetary conditions too accommodative. ”
Link to full article:
http://www.bloomberg.com/news/articles/2015-03-25/forget-when-the-fed-will-raise-rates-how-is-still-problematic
From the same article. A main policy tool of the Fed are Repo’s or Reverse Repos. These transactions are every day events. These tools have been used daily for the last 30 years (more). The description of Reverse Repo:
In an overnight reverse repo, the Fed borrows cash from counterparties using securities as collateral. The next day, it returns the cash plus interest to the lender and gets the securities back.
Ok? The Fed borrows cash, pledges securities as collateral for the borrowed money. It pays the money back with interest the next day.
Again, this is completely normal stuff. Routine, done daily in very big amounts. So when you say, “The Fed does not borrow. Period.” You’re wrong.
Krasting even conceding that Reserve Repos are a type of borrowing this would seem to have exactly zero to do with the claims you made to start this ball:
“The $6.9B of interest expense reported by the fed is $2.5T*IOER. What happens to the Fed if IOER goes to 4%? Then $2.5T*4% = $100b.
So if/when interest rates rise the Fed will HAVE to borrow money at higher rates. As it incurs higher interest cost its net income will decline. If rates do get to 4%, the the Fed would have negligible annual income.”
Now I will freely admit I had no knowledge of what IOER even was when this discussion started but I still don’t see that it could have the impact you suggest. For a couple reasons.
1) IOER is ‘Interest on EXCESS Reserves’ and the expectation is that an improved economy will induce banks to lend those funds out and reduce those balances which in turn will reduce interest expenses.
2) There is no requirement to pay IOER that can’t be reversed to put us back in a pre-2008 situation
3) There is no reason why IOER should exactly track the Federal Funds Rate. Indeed this from Wiki suggests they shouldn’t and wouldn’t https://en.wikipedia.org/wiki/Excess_reserves
“On March 20, 2013, excess reserves stood at $1.76 trillion.[19] As the economy began to show signs of recovery in 2013, the Fed began to worry about the public relations problem that paying dozens of billions of dollars in interest on excess reserves (IOER) would cause when interest rates rise. St. Louis Fed president James B. Bullard said, “paying them something of the order of $50 billion [is] more than the entire profits of the largest banks.” Bankers quoted in the Financial Times said the Fed could increase IOER rates more slowly than benchmark Fed funds rates, and reserves should be shifted out of the Fed and lent out by banks as the economy improves”
4) You simply assume a 4% Rate.
Of these I think the strongest is Bullard’s point. Your argument suggests that the public will simply accept a $100 billion a year transfer to the banks. For money that literally does nothing. At a rate 16X higher than today. And present that as if it wasn’t exposed to policy. Sorry you need to spell that argument out a little more.
Or you can just claim that you won the war by dredging up the example of Reverse Repos which have Fuck All that I can see with your original argument. Good One!!!
As for the Bloomberg article I am afraid I don’t understand it. But then again the point of this post had exactly zero to do with the level of excess reserves or for that matter Fed monetary policy. I was making (again) a point about how people should not just use the ‘Net Interest’ number blindly without considering how much of that actually represented interest paid to the Fed and rebated to Treasury. Currently on the order of $100 Billion a year. It was not intended to address all the mysteries of the world including IOER, the precise orbit of Hailey’s Comet or the current Price of Tea in China.