Fed Dividend (Oct. 7)

Mike & Co. ––

In comments to bank executives at a private meeting in Washington yesterday, Mitch McConnell said that there was no way he would remove the provision that reduces the Fed dividend from six to 1.5 percent for banks with more than $1 billion in consolidated assets.  Mechanics of the dividend and more on the latest below.

Also, an excellent piece in yesterday’s WP on the investor-state dispute settlement (ISDS) chapter of the TPP: http://www.washingtonpost.com/blogs/monkey-cage/wp/2015/10/06/the-tpp-has-a-provision-many-will-love-to-hate-isds-what-is-it-and-why-does-it-matter/

Till tomorrow,

Dana

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It was good a good run for the hitherto obscure 102-year old annual dividend of six percent that Federal Reserve System member banks receive from the Fed.  But now Senate Majority Leader McConnell and Finance Chair Hatch have agreed to slash the dividend to 1.5 percent and use the money — $17 billion over ten years — to help pay for the Highway Trust Fund reauthorization bill.

The idea of cutting the dividend first appeared in a budget proposed by the Congressional Progressive Caucus in March 2014.  The proposal was included this past summer in a highway-funding bill by McConnell and was passed by the Senate in July.  House GOP leaders haven’t moved on the Senate bill and haven’t taken a position on the bank-payments issue.  The House will decide its approach on the highway bill before month’s end.

On September 11, prompted by the proposed dividend cuts and industry’s response, House Financial Services Chair Jeb Hensarling requested that the GAO study the Fed stock ownership structure and report back to Congress.  Hensarling sought a review of requiring Fed member banks to buy stock and why Congress set a six percent dividend and what the implications are of reducing that rate, both on the federal budget and on Fed system membership.

Under the terms of Section 7 of the original Federal Reserve Act of 1913, as a condition of membership, regional banks must purchase “stock” in their local Federal Reserve Bank.  But owning Reserve Bank stock bears little resemblance to owning stock in AT&T or General Motors.

First, all nationally-chartered banks are legally required to join the Federal Reserve System as members and purchase this stock.  None of the stock has ever been publicly traded.  The banks are the only shareholders. The stock has a set value that never changes, and banks cannot sell, trade, or pledge the stock as collateral.  With the price constant, banks cannot lose money on the stock; even if a regional Federal Reserver Bank somehow disbanded, the government is required by law to pay out stockholders at face value.

The stock purchase must be equal to six percent of the bank’s total capital and surplus — half gets paid in to the regional Reserve Bank, and the other half is on call. If the bank’s capital goes up they must purchase more stock, and if it falls they get a refund.

So the stock is a kind of membership services  to fund the regional Reserve Banks’ activities.  Only in this case, the stock pays a sic percent dividend every year — a large, lump-sum annual payment to the roughly 2,900 banks in the Federal Reserve system.  Within 17 years, banks automatically earn back the total purchase in nominal dollars, making any future dividends pure profit.  Last year, the program totaled $1.69 billion, including roughly $310 million for Bank of America and $250 million for Citigroup Inc.

Industry may have an ally in Federal Reserve Chair Janet Yellen. She’s expressed concern over the dividend reduction, saying it “could conceivably have unintended consequences, and I think it deserves serious thought and analysis.”

But the die is probably cast in Congress.