The world was reminded of the cozy relationship between The Fed and The Treasury again today as Janet sent Jack $92.0 billion of freshly ponzi'd net income for 2016 providing the federal government with an important source of funding. This, however, is down almost 6% from 2015 and despite a considerably larger balance sheet is the lowest remittance since 2013 due to doubling the handouts to the major banks to $12 billion last year.
As Reuters reports, part of the decline is due to a drop of about $2.6 billion in what the Fed earns on its holdings of U.S. Treasury bonds and mortgage-backed securities accumulated in fighting the 2007 to 2009 financial crisis.
But most of it is a result of the interest paid on excess reserves held by commercial banks at the 12 regional Federal Reserve institutions. Banks are required to hold some reserves, but are allowed to deposit more if they choose.
Between more cautious lending and weak economic growth, total reserves have been at historically high levels since the financial crisis -- roughly $2 trillion as of the end of the last year compared with a few billions of dollars in more typical times.
When the Fed increased its target interest rate in Dec. 2015 by a quarter of a percentage point, to a range of between 0.25 and 0.5, it increased the rate paid to banks as well - and pushed its overall reserve interest costs from $6.9 billion in 2015 to $12 billion last year.
The increase may draw attention from lawmakers who have been critical of the Fed paying money to large commercial institutions. The central bank argues that the payments are its most effective way to push rates higher: by offering interest on excess reserves, the Fed forces banks to raise the rate at which they are willing to lend to each other.
In the last 15 years, The Fed has handed over $880 billion to The Treasury...
As is clear in the chart above, a decade ago, back when the Fed was a smaller size, Fed remittances were fairly steady, in the neighborhood of $20 billion a year. This all changed after 2008 as the Fed’s Quantitative Easing programs increased the amount of interest-earning assets that would generate funds to transfer back to the Treasury.
Big Bucks for the US Treasury
For the US Treasury, Fed remittances are something of a free lunch. When someone buys a Treasury bond, the government must pay them interest. This applies to the Fed as well, but then at year-end the Fed remits the interest back to the Treasury.
As we noted previously, in more “normal” times (i.e., prior to 2008) around 7 percent of the Treasury’s interest payments were paid back to it by the Fed. This figure has grown to over three times that amount over the past few years...
Implications for Fed “Independence”
As much as economists talk about the independence that the Fed holds from Congress, these remittances represent a strong link. In fact, since they enable federal spending they create a form of quasi-fiscal policy for the Fed to use, in addition to its more common monetary policy options.
Consider that since Treasury debt is almost never repaid in net terms (old issues are retired but replaced with new debt issuances), the true cost of financing the US government’s borrowing is not the gross amount of debt outstanding but the annual interest expense it faces. Viewed this way, nearly half of the Treasury’s borrowing was financed by the Fed last year. Absent these Fed remittances, Congress would need to look at either an alternative funding source (though I am not sure how many takers there are for the Fed’s $2.5 trillion Treasury holdings) or make some serious cuts.
How serious? NASA’s operating budget was roughly $18 billion last year, so a lack of Fed remittances would cause the Treasury to cut around five NASA-sized programs. Alternatively, the governments Supplemental Nutrition Assistance Program (previously known as “food stamps”) cost $70 billion in 2014. Without the Fed’s remittances, Congress would have to stop paying out all food stamp recipients plus it would be forced to defund almost two NASAs.
More important in many Americans’ hearts is their monthly social security check. In 2014, $830 billion of social security checks were mailed out. Without Fed remittances, retirees might see their monthly check cut by about 12 percent.
For those concerned with the burgeoning size of the federal government, putting a stop to Fed remittances would put a serious dent in public finances and force some serious thought as to what programs need to be cut.