Why the Fed Shouldn't Compete With Private Banks
Do we want the U.S. Federal Reserve Board to operate as a commercial bank -- and compete with our private banking system? The Fed apparently wants to, and it's a policy shift that could greatly expand the mission of the Fed.
Last week, while most of the world's Fed watchers were focused on interest rate changes, another key Federal Reserve decision was buried in that news cycle: The Fed is moving in on the real-time payments business. This is the business of speeding up financial transactions between people and financial institutions.
Federal Reserve Chairman Jerome Powell confirmed that the Fed is "seriously considering" building its own real-time payments network, one that would compete with a new system built by The Clearing House, a consortium of large financial institutions.
This latest pronouncement makes many private-sector actors anxious because no private company wants to compete with the Federal Reserve. No private firm can safely charge as low a price as the Fed or absorb high costs.
The Fed has an obvious advantage in any venturing into activities now conducted by private lenders: It has effectively the lowest borrowing costs in the world because the full faith and credit of the U.S. government stands behind it. The Fed can't go bankrupt and by its enormous size and stature is the behemoth in the banking universe.
In this particular case, the mission creep by the Fed is especially ill-advised because the Fed's history with real-time payments is spotty. Moreover, the Fed wants to intrude on a $1 billion private-sector network of clearing financial transactions in a speedy and efficient way.
Back in 2015, the Federal Reserve convened the Faster Payments Task Force to "identify and assess alternative approaches for implementing safe, ubiquitous, faster payments capabilities in the United States."
The Fed insisted that it was acting primarily as a catalyst, and the task force announced that "ultimately, implementation of proposals will be driven by the private sector."
And the private sector stepped up with a massive investment to drive this technology forward.
The Clearing House, a private association owned by 25 large banks, launched its own $1 billion system -- Real-Time Payments -- in November 2017. The new network is open to all federally insured depository institutions, it charges all customers the same flat-rate pricing (no bank gets a volume discount), and the governing body includes both Clearing House members and nonmember financial institutions.
There is no good reason for the Fed to start its own network to compete with RTP. The Fed says it can do this more efficiently and at lower cost, but this is only because of its exalted status and power.
The smaller banks, under the auspices of the Independent Community Bankers of America, have been lobbying the Fed to build its own network competitor, arguing that the Fed needs to "Stop a Megabank Monopoly." But the idea that an association of 25 banks is a monopoly that will jack up prices on its own member banks is ludicrous.
The main reason that so few private firms currently operate in the clearing and settlement business is because the Fed has a history of driving private firms out of the business (sometimes by charging below-market prices), even when they're doing just fine. (By the way, these actions, if by any private firm or consortium, could be labeled monopolistic.)
Many people view the Fed running its own network as the function of a "public utility" that merely supports "payment innovations by banks and non-bank financial technology companies worldwide," but viewing the Fed as a regulated "public utility" could hardly be more wrong and dangerous.
The Fed can also loan money at lower costs than private banks. Should it encroach into that area as well? Super-regulators like Massachusetts Sen. Elizabeth Warren already want the U.S. Postal Service to provide retail bank accounts, and others on the left have already proposed that the Fed directly compete with private banks as a "public option."
It sure seems as though small community banks are making a deal with the devil in calling for the Fed to run its own real-time payment system.
Some proponents of the Fed building its own competitor to the private RTP network argue that this service has large network effects and exhibits similar characteristics to a natural monopoly. Ironically, it almost certainly will evolve into a monopoly if run by the government. Government-provided services always inhibit private competition. Amtrak and the Postal Service are two good examples.
To confer a special status to this product as "a special public purpose" only serves to justify further government encroachment on the private economy. We have seen these same fallacious arguments with respect to the internet from its earliest days, and thank goodness we never had a public option for search engines, social media, operating systems and so on.
The similarities here to the Internet are reasons why the Fed and Congress should flatly reject the idea that a private RTP will become monopolistic. This is a dynamic new industry facing dramatic technology changes and thus constant competitive threats from both existing and potential companies and innovators. This fact, along with the regulatory threats it faces from the Fed, prevents the RTP from abusing its market position.
Most importantly, the Fed's entrance into this market very likely violates its own policy guidelines with respect to introducing new services. Those guidelines state that "the service should be one that other providers alone cannot be expected to provide with reasonable effectiveness, scope, and equity."
These criteria pose a particularly high hurdle regarding real-time payments because the private sector is already providing the service.
So far, the Fed has justified its stance based on the notion that "coordination challenges" and "high fixed costs" will prevent other firms from providing competing services with "reasonable effectiveness, scope, and equity." This strikes us as a highly self-serving analysis that simply justifies the expansion of the Fed's already enormous independent powers over the banking system.
The Fed should stick to its traditional policy and announce that it will remain a neutral facilitator of real-time payments. If it won't, Congress should intervene in its oversight role and find out why the Fed feels compelled to compete with private banks.
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