This FT article has turned the emotional dial much too high, as the media often does.
Officials at the US central bank fear it could create a public-relations nightmare after the Fed was lambasted for rescuing banks during the financial crisis. It is one factor prompting some inside the Fed to reconsider the eventual “exit strategy” from easy monetary policy.
In an interview with the Financial Times, James Bullard, president of the St Louis Fed, said: “If you think of the profitability of the biggest banks, if you’re going to talk about paying them something of the order of $50bn – well that’s more than the entire profits of the largest banks.”
But amidst all the talk of “fear” and “nightmares”, the lede is buried:
Mr Bullard said that neither interest paid to banks nor possible losses on exit made any difference to the substance of monetary policy.
There’s two things that are getting mixed up here – sensitivities over monetary policy and sensitivities over big banks.
I’ve heard dozens of times from investors and market people that the Fed is going to have huge problems if (when) it makes losses on its bond portfolio in coming years as interest rates rise.
It’s a classic example of not fully understanding other people’s objectives or bottom line. For markets, the bottom line of dollars and cents is absolutely important. If you make losses, you’re finished. For the Fed, the bottom line is the inflation and employment numbers. It is all about the public interest and the health of the United States economy. Their prime objective is not to make a profit to pay to the Treasury.
I’ve heard many times in Fed discussions that the Fed is not a hedge fund. Yes, losses would be an embarrassment for Bernanke or his successors to explain to Congress. Yes, there could be criticism which could conceivably slightly damage the Fed, and there is some sensitivity in the institution about that.
But for a central bank, losses are ultimately just an accounting technicality, not a matter of survival like a hedge fund or asset manager. The central bank creates money in the first place. Indeed, the payments to banks, as part of the Fed’s relatively new interest on excess reserves policy, are also the principal reason why the Fed is confident it can mop up trillions of dollars of liquidity effectively when necessary. They are the newly valuable tool which mean various outside predictions the Fed’s huge balance sheet will produce catastrophic inflation are wrong.
And, as the article notes, most of the payment will be passed on to bank depositors who will be paid higher interest rates by the banks in any case.The Fed can also argue lower payments to Treasury are the price paid for avoiding a Great Depression, and if Congress would have preferred a Depression, they can tell their voters that (more politely, of course.)
Big banks are the “fear”
Instead, what is at issue here is a second debate. Bullard is President of a regional Fed, and most regional Feds have been besieged with complaints from their local banks since the crisis. The local banks that sit on regional Fed boards argue big banks were bailed out, yet smaller regional commercial banks and community banks were let fail. There is a great deal of bitterness in regional banking circles.
Regional Fed Presidents think of the national interest, rather than just representing the interests of their district. But much of the reason regional Federal Reserve Banks were founded in the first place,in 1911, was to prevent the central bank turning into a mere representative of the views and interests of the big Wall St institutions. The regional Feds tend to be very skeptical of overconcentration of the financial system. They are a vital part of the Fed discussion.
>So the most important “optic” here is not so much Fed losses and monetary policy. It is perceptions that the Fed has been too easy on the big banks. And Bullard is doing his job in being sensitive about that, just as the Federal Reserve Act intends. It isn’t generalized “fear.” He is raising policy points that should not be reduced to emotion or public relations.