Rarely does a day go by when some House Republican doesn’t demand an end to Federal Reserve funding of the Consumer Financial Protection Bureau (CFPB). But you will never hear about the Fed’s direct subsidy to private banks that costs over three times as much as the total CFPB budget.
The subsidy comes in the form of a 6 percent dividend, paid on stock that over 2,900 banks purchase to participate in the Federal Reserve system. Very few places where ordinary Americans park their money offer such a risk-free benefit. In 2012 (the last year with available data), the Fed gave away $1.637 billion in dividends to banks, tax-free in the majority of cases. And the Fed has been doing this for the last 100 years. It’s one of the many unknown ways the Fed extends special benefits to Wall Street.
The dividends are one example of the strange manner in which the Fed is both a public and private entity. The Federal Reserve Board of Governors, the main policymaking body, is appointed by the President and confirmed by the Senate. But there are also twelve regional Federal Reserve Banks, whose presidents participate in the committee that sets monetary policy. These Reserve Banks operate as private corporations owned by member banks in their districts, even though they also regulate the same banks. Their websites have a .org, not a .gov, suffix.
As a condition of membership, regional banks must purchase “stock” in their local Federal Reserve Bank. But as the Fed notes, owning Reserve Bank stock bears little resemblance to owning stock in AT&T or General Motors. First, all nationally-chartered banks must join the Reserve system and purchase this stock. No public stock has ever been issued; 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 Reserve Bank somehow disbanded, the government is required by law to pay out stockholders at face value. The stock purchase must equal 6 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.
In some ways, the stock is a membership fee to fund the regional Reserve Banks’ activities. Only in this case, the stock pays a 6 percent dividend every year that the Federal Reserve makes money, as per Section 7 of the original Federal Reserve Act of 1913. The Fed’s numerous advantages as a market player means it almost always turn a profit, so in practice this is 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 stock purchase in nominal dollars, making any future dividends pure profit. Banks like JPMorgan Chase, around since the founding of the Federal Reserve, have reaped this benefit for 100 years.
For further context, none of the 30 stocks that make up the Dow Jones Industrial Average offer more than a 4 percent annual dividend, and the average dividend yield of Dow stocks is 1.94 percent, less than a third what banks make with their Fed stock.
Why did the Federal Reserve Act initially offer such a generous dividend to member banks? It was essentially part of a marketing campaign. “At the time the Fed was not terribly popular with the banks, and they wanted to attract members,” said Allan Meltzer, professor of political economy at Carnegie Mellon University and a historian of the Federal Reserve. “They had to give up a major source of revenue, the charge they made for check clearing. Back then, if you received a check for $10, you might get back $9.50.” The dividend was seen as a way to entice banks into joining the Federal Reserve system.
This is largely an anachronism today. First off, national banks must join the Federal Reserve system, so there’s no need to offer a carrot. State-chartered banks are not required to join, but they are nonetheless subject to most banking system regulations, and routinely use the services the Fed provides, like check clearing (from which they cannot, by law, skim money off the top). Member and non-member banks alike even have to hold cash reserves within the Reserve system. “All banks have to meet the requirements of membership,” Meltzer said, removing the need for incentives.
There aren’t other industries where the businesses own stock in the agency that regulated them—and receive a dividend payout from that agency. And it’s not like the stock purchase doesn’t already come with perks. Member banks receive a vote for the board of directors for the regional Reserve Banks who regulate them. The 6 percent dividend is like a cherry on top.
The dividend is hardly the biggest benefit bestowed by the Federal Reserve on member banks. They get access to ultra-cheap loans through the discount window, various liquidity programs to ensure cash flow, and an array of services like check clearing, wire transfers, servicing of savings bonds, physical inventory of currency, and more. The Congressionally-approved TARP program was a drop in the ocean compared to the support the Fed gave banks during the financial crisis. Since 2008, banks have even received interest on their excess cash reserves, to the tune of close to $5 billion a year, without taking any risk.
But if the 6 percent dividend on capital stock isn’t the Fed’s largest gift, it may be the most brazen—a risk-free entitlement program that has operated in obscurity for 100 years. Most member banks don’t even have to pay corporate taxes on the dividends, unlike most Americans who pay anywhere from 15-20 percent in dividend taxes. An update to the law imposed taxes on dividends from Federal Reserve stock to any shares issued after March 28, 1942. But most Wall Street banks have charters with roots back to the 19th century, and are grandfathered in with the tax exemption.
Any Federal Reserve profits not handed over to banks go to the Treasury Department. The expansion of the Fed balance sheet has led to record profits remitted to the Treasury, including a record $88.9 billion in 2012 and another $77.7 billion last year. But while this $1.6 billion annual giveaway to banks is small in relative terms, it’s a good chunk of change compared to what Congress routinely fights over. For example, Congress recently settled on $8.6 billion in food stamp cuts over ten years as part of the farm bill; this Fed dividend to banks represents twice that amount on an annual basis.
The Congressional Progressive Caucus does plan to finally suggest that this outdated program be terminated in its upcoming budget. Presumably the banks will fight this. But with no longer any reason to incentivize Federal Reserve membership, the dividend has become a hidden corporate welfare system for the financial sector. Large banks do very well on their own without having to be compensated for doing nothing by the agency that’s supposed to supervise them.