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A lawsuit against the Federal Reserve Bank in New York could complicate the central bank's efforts to control short-term interest rates as market surveillance intensifies.
TNB USA Inc. argues in a federal lawsuit filed in late August that it was wrongly blocked in its pursuit of a "main account" at the Fed that would allow it to earn interest on deposits placed in the books of the Fed.
According to analysts, if TNB obtained approval to offer deposit accounts to its customers and other banks copied its model, the development could pose a threat to the Fed's control of short-term rates since the crisis of 2008.
Instead of targeting a specific short-term rate, as before the financial crisis, the Fed now sets a firm range between the high-end deposit bank payment rate and the available overnight buy-in rate an approved list of managers funds and other institutions at the bottom of the scale. The fed-fund rate floats between the two.
According to analysts, TNB and other banks such as this one could thwart this system by collecting interest at a higher rate and offering this rate, minus a spread to cover costs and benefits, to institutions that deposit money. money with them.
"I applaud the skill of this," said Tim Duy, professor of economics at the University of Oregon. "This spread was sitting outside and someone has found a way to take advantage of that."
The Fed's range for the funds rate is now between 1.75% and 2%, with an interest rate on excess reserves of 1.95%. We expect the Fed to strengthen this range when officials meet this week.
The TNB and banks like this would allow companies that would get the lowest repo rate to get a higher return. This could make the floor rate questionable. The Fed would still have a lot of control over short-term rates, but the lower floor could stop being a significant rate.
Some Fed observers say the threat to the rate control regime may not be such a good deal. For some time, eligible companies have shown little real interest in obtaining the repo rate, as these companies have put their money to work elsewhere, with better returns.
George Selgin, a member of the Cato Institute, attributes this situation in a note to the Fed's key rate trend to increasingly follow the rise in market-determined interest rates in times of increasing budget deficits.
Regardless of market conditions, TNB says it does not try to break the system, and the Fed is told how it will limit its activities to achieve this. The Fed "clearly has the legal obligation" to grant the official account, said James McAndrews, a former chief research officer at the Fed who runs TNB. He also believes that the TNB model is entirely complementary to the Fed's monetary policy objectives and reinforces what is now in place.
The Fed did not say why it did not approve TNB's request beyond unspecified "political concerns," according to TNB's complaint. Central bank observers say denial is essentially unprecedented. TNB operates under a temporary charter that Connecticut's banking regulators granted in August 2017 and expires next year.
The New York Fed has so far not responded to the complaint and the Fed Board of Governors has refused to respond to these claims.
Peter Conti-Brown, a professor of legal studies and business ethics at the Wharton School at the University of Pennsylvania, said he "was not convinced that the Fed had the legal power to deny TNB its main account ". it has the legal power to use the discretion to refuse "an application like TNB's, said Conti-Brown.
The TNB model has longer-term implications. If that proved popular – and there is no way of knowing if this would happen – it could serve as a first step to a longer march to connect the public to the central bank more directly. Some academics have argued that monetary policy could be more effective if people and businesses were allowed to do direct banking with the Fed through interest-bearing accounts.
Fed policy changes could then bypass the inconstant financial markets and be felt at the consumer level, which in theory would make rate changes more powerful. TNB may not be looking for such a result, but a successful performance of its model could turn the wheels for such a world.
The TNB is "another manifestation of how innovation is ahead of regulation," said David Beckworth, of the Mercatus Center at George Mason University. "The fear of the Fed is not only to destroy the floor system, but to bring its balance sheet more and more entities and ultimately the public."
Write to Michael S. Derby at [email protected]
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