When people think about the Federal Reserve, to the extent that they do anyway, I suspect the first thing people think of is monetary policy. There are other legs to the stool, including bank regulation and payment system services.
You and I use banks when we pay people money. Well, banks pay each other money too, lots of it – for their own account, as well as for the account of their customers. Banks pay each other money via correspondent banking relationships, private payment system services, and services provided by the Federal Reserve.
One of the largest services out there is the Federal Reserve’s “Fedwire” wire transfer system, which moves over a trillion dollars – every day.
The Federal Reserve’s payment services are provided under federal law dating to 1980 that requires the Fed to fully recover the costs of the system. And every year, the Federal Reserve produces income statements for its payment services, asserting full cost recovery.
There have been a few hiccups on the trail of these annual reports, however. For example, in the late 1990s, members of the Board of Governors were regularly testifying how Fedwire served as a source of subsidy for banks -- even as the Fed produced reports annually asserting full cost recovery, and Fed leaders were also issuing statements that Fedwire was not a source of subsidy, given that it fully recovered its costs.
Hmm. Subsidies don’t normally get priced above cost. This suggests the Fed knew that it wasn’t pricing Fedwire legally.
Dial forward to late last month. The Government Accountability Office (GAO) released a new report with some recommendations for the Federal Reserve to improve its accounting for payment service cost recovery.
Some good questions arise whether the GAO’s recommendations were really just baby steps, compared to what the law and economic efficiency would require.
Particularly in light of trends in daylight overdraft credit extended by the Fed on Fedwire in mid-to-late 2008, when all hell was breaking loose. Take a peek at what was happening in September and October 2008 in peak overdrafts in this table, just before the Fed (and Treasury) unleashed a flood of liquidity-love in our banking system.