Senate Poised to Cut Fed Dividend as Part of Highway Bill

WASHINGTON — The Senate began debate Thursday on a bill that includes a provision that would cut the dividend that member banks receive from the Federal Reserve System, a measure that banks, regulators and lawmakers alike are calling shortsighted. 

The overall highway transportation bill cleared a key procedural vote on Wednesday after the Senate voted 62 to 36 to begin debate on the bill. That came just a day after Senate leaders had failed to win the necessary support to invoke cloture.

But the financial services industry is focused primarily on an obscure provision that would slash the dividend for member banks' stock in the Federal Reserve System to 1.5% from 6% for all member banks with more than $1 billion in assets. The measure is estimated to generate around $1.7 billion in annual revenue and is designed to help pay for the costs of the highway transportation bill.

But federal regulators have warned cutting the dividend may be a mistake.

"I would be concerned about reducing the dividend could have unintended consequences for banks' willingness to be part of the Federal Reserve system, and this might particularly apply to smaller institutions," Fed Chair Janet Yellen said last week. "I would say that this is a change to the law that could conceivably have unintended consequences and I think it deserves some serious thought and analysis."

Federal law requires Fed-member banks to buy a set amount of stock in the Federal Reserve system. That stock's value doesn't change and may not be pledged or sold or otherwise touched. In exchange for effectively freezing the capital used to buy the stock, the Fed pays an annual dividend, which has been set at 6% since the central bank was established in 1913.

Senate Banking Committee Chairman Richard Shelby, R-Ala., has similarly warned against cutting the dividend, saying that it made little sense to fund a surface transportation measure with dividends from the Federal Reserve.

"I think that's a pretty far reach, but, you know, people look for money anywhere they can get it," Shelby told Yellen. "That's something that I think we'd better be working together on, I hope."

The American Bankers Association, Financial Services Forum, the Clearing House Association, Financial Services Roundtable and Independent Community Bankers of America sent a letter last week to Senate Environment and Public Works Committee Chairman James Inhofe, R-Okla., and lead panel Democrat Barbara Boxer, R-Calif., decrying the measure, saying that the Fed dividend is mandated by law and not a significant source of income for any bank. Cutting that dividend so drastically would have dire consequences on the financial sector, the groups said, and such a move should at least be debated and analyzed before becoming law.

"This proposed policy change undermines a key agreement that has underpinned the United States banking system for 100 years," the letter reads. "Dramatically reducing the rate to pay for a completely unrelated congressional priority will weaken the financial stability of banking institutions and reduce liquidity available in the financial system."

Paul Merski, the executive vice president for congressional relations at the ICBA, said the provision is just "another onerous hit to" community bank revenues.

"This is policy that's been in place for a hundred years," Merski said. "It's preposterous that you would use this hit on community banks to pay for a highway bill. It's a counterproductive proposal that is going to hurt lending."

But the provision is popular with lawmakers because it's perceived as punishing the largest banks.

"The biggest banks are still among the least popular institutions in this country," said Jaret Seiberg, a Washington policy analyst with Guggenheim Securities.

If this provision "can be rewritten in a certain way, and it just covers the big guys and excludes the smaller ones, then I believe it has a real shot," he said, of being included in the final highway funding bill.

The industry also objects to a separate provision that would extend a hike in guarantee fees charged by Fannie Mae and Freddie Mac through 2025. Congress originally hiked G-fees in 2011 by 10 basis points, but that provision is slated to expire in October 2021.

The idea to direct Fed dividends to the highway fund first appeared in the 2014 Congressional Progressive Caucus' alternative budget. The budget pledged in a summary to halve the dividend as a way of ending "excessive Fed dividends for Wall Street."

But Don Kohn, a former Fed governor and now a senior fellow at the Brookings Institution, told the House Financial Services Committee on Wednesday that because the Federal Reserve stock has no utility for the banks except as a prerequisite for membership in the system, the required purchase of that stock is, in effect, a tax. The dividend was included in the 1913 Federal Reserve law in order to nullify that effect and incentivize participation in the system.

Whether 6% is still an appropriate level is debatable, especially in the current financial climate, Kohn said, but lowering it to 1.5% likely goes too far.

"I am not sure 6% is the right rate, but let's recognize that by lowering it to say 1.5% on the proposal — in effect you are placing a tax on banks over $1 billion," Kohn said.

Brian Collins and Rob Blackwell contributed to this article.