A critical part of the Federal Reserve’s monetary policy faces bipartisan scrutiny from lawmakers worried that the central bank is paying subsidies to big banks.
At a congressional hearing Wednesday, members of both parties grilled Chairwoman Janet Yellen over the Fed’s policy of paying banks interest on excess reserves, expressing anger about a key part of the Fed’s strategy for returning to normal monetary policy over the next few years.
“It looks like we’re about to have bipartisan concern on this issue,” said Rep. Maxine Waters, the ranking Democrat on the committee.
Waters said that the 0.5 percent interest rate paid on excess reserve to banks is “a subsidy to keep them from lending money,” referring to specific sums paid to Goldman Sachs and JPMorgan Chase.
“These banks — too big to fail — who we are fighting every day because of their predatory lending, etc., are getting support from the Fed?” Waters asked. “Please, please explain that.”
Waters’ concerns were voiced by other members of the House panel, including its staunchly conservative chairman, Jeb Hensarling of Texas.
Throughout the hearing, Yellen defended interest paid on excess reserves as an essential tool for the Fed and one used by other central banks throughout the world.
The Fed began paying interest rates on excess reserves in 2008. During the recession, banks looking for safe returns parked trillions of dollars at the Fed. Today, banks have more than $2.3 trillion in excess reserves at the Fed.
Yellen noted that those reserves have allowed the Fed to expand its holdings of bonds and generated large profits for the Fed, which are remitted to the Treasury. Those earnings show up “in the taxpayers’ pocket. It is money that Congress can use to address all the problems you’ve discussed,” Yellen said.
Political concerns about the payments are likely to grow, however, as the Fed raises rates as planned, entailing larger amounts paid to banks.
Under the strategy the Fed has laid out for raising rates and ultimately shrinking its balance sheet, the Fed’s profits are likely to shrink. Eventually, the Fed could suffer losses, a prospect that experts warn could create problematic appearances for the central bank, given that it would be paying big banks for excess reserves at the same time.
The Fed’s plan for normalization, most recently updated in December, involves setting the interest rate paid on reserves at the high end of its target range for short-term rates. The logic in doing so is that arbitrage will ensure that the specific rate the Fed targets, the federal funds rate, cannot fall much below.
