Who should be allowed to deposit money at the Fed?
By Scott Sumner
A recent paper by Morgan Ricks, John Crawford, and Lev Menand argued that the public should be allowed to have a bank account at the Fed:
Among the perks of being a bank is the privilege of holding an account with the central bank. Unavailable to individuals and nonbank businesses, central bank accounts pay higher interest than ordinary bank accounts. Payments between these accounts clear instantly; banks needn’t wait days or even minutes for incoming payments to post. On top of that, central bank accounts are pure money—economically equivalent to dollar bills—meaning they are fully sovereign and nondefaultable no matter how large the balance. By contrast, federal deposit insurance for ordinary bank accounts maxes out at $250,000—a big problem for institutions with large balances.
The time has come to end this special privilege of banks. We propose giving the general public—individuals, businesses, and institutions—the option to have a bank account at the Federal Reserve. We call it a FedAccount. FedAccounts would offer all the functionality of ordinary bank accounts with the exception of overdraft coverage. They would also have all the special features that banks currently enjoy on their central bank accounts—including unlimited secure balances, instant in-network payments, and a higher interest rate—as well as some additional, complementary features.
This sort of proposal has both pros and cons. In my view, the biggest “pro” is that it would allow for the abolition of deposit insurance, which I regard as one of the most underrated flaws in our financial system. I emphasize “would allow” rather than “would lead to” because I fear that it would not in fact lead to the abolition of deposit insurance. Special interest groups would probably prevent that outcome. Indeed we might end up with both access to the Fed balance sheet and FDIC, not my preferred regime.
On balance, my preference would be to go back to the pre-2008 regime, where there was no interest paid on bank reserves and the Fed balance sheet was much smaller. But I would support a deal that combined public access to interest earning Fed accounts with abolition of FDIC. (BTW, unlike most other economists, I see “too big to fail” as a far smaller problem than FDIC.)
Even if the Fed does not allow private accounts, it ought to be possible for a financial institution to provide a similar service. And according to the WSJ, the private sector has indeed spotted this market niche:
TNB USA Inc.—run by a former top New York Fed staffer—said its primary business activity will be to enable large institutional money-market investors to earn higher interest rates from the Federal Reserve than they could otherwise, according a complaint filed in federal court Friday. Such investors include pension funds, companies and other entities managing large sums of money.
But first TNB, based in Connecticut, needs to open an interest-bearing account at the New York Fed, like those held by many large banks. . . .
[I]ts “sole business will be to accept deposits from the most financially secure institutions” and place that money in an interest-bearing Fed account, “permitting depositors to earn higher rates of interest than are currently available to nonfinancial companies and consumers,” the filing said.
TNB’s customers will primarily be institutional money-market investors, but it would also accept deposits from foreign central banks, the filing said.
Although this proposed “narrow bank” would primarily serve large institutions, the broader public would benefit from higher returns on money invested with pension funds, etc. So what does the Fed think of this proposal?
The Fed hasn’t granted or rejected TNB’s request, a process begun in August 2017, or provided a formal reason for not acting. TNB alleges in its court filing that New York Fed officials were prepared to open the account, but the Fed’s Washington-based board of governors blocked it because of unspecified “policy concerns.”
The plaintiffs said in the lawsuit they attributed the decision to the board chairman, Jerome Powell, based on their conversations with New York Fed officials.
TNB is asking the U.S. District Court for the Southern District of New York to order the New York Fed to open the account. The suit cites a 1980 law saying such accounts shall be available to any qualified depository institution that receives deposits other than trust funds.
My first reaction is, “that doesn’t look good”. My second reaction is, “I really don’t know enough about this to criticize the Fed’s decision”. And my third and final reaction is back to “that doesn’t look good”, because the Fed’s “policy concerns” are unspecified. I can imagine how there might be policy concerns that I’m not aware of. What I can’t imagine is why these policy concerns need to be “unspecified”.
I’m especially concerned by the fact that people who know much more about Fed policy than I do are equally puzzled:
Andrew Levin, a former top Fed staffer and currently a Dartmouth College economic professor, said the Fed’s current rate-setting system is designed to attract deposits—with the 1.95% interest-on-reserves rate drawing them from banks and the 1.75% rate paid on its reverse-repurchase program drawing them from money-market investors. Through this program, the Fed sells a Treasury security to a participating firm and agrees to buy it back the next day with interest.
He said the Fed should welcome banks like TNB, adding they would make monetary policy work better because they would draw more from money-market investors. “The Fed should be excited about it and try to foster it,” he said.
The Fed seems reluctant to say no, as then it would have to specify its actual concerns. Rather they seem to be dragging out the process in the hopes that the proposal will be quietly dropped. Hence the lawsuit. I suspect the Fed believes that the actual reasons for its opposition would be politically unpopular.