Bernanke Asks Congress to Accelerate Authority to Pay Interest

Federal Reserve Chairman Ben Bernanke asked Congress to accelerate the date when the Fed can pay interest on reserves, a power that would give it better control over interest rates and more leverage to battle the credit crunch.

Bernanke

In the letter to House of Representatives Speaker Nancy Pelosi May 13, Mr. Bernanke noted Congress gave the Fed the authority to pay interest starting 2011 because “the payment of interest on reserves would contribute to the efficiency of the financial system… In order to prevent further delay in realizing the benefits of this legislation, we recommend that the date be changed to make the legislation effective immediately.” Similar letters were sent to Senate Banking Committee Christopher Dodd, Democrat of Connecticut, and the committee’s senior Republican, Richard Shelby of Alabama.

The letter was expected. The Wall Street Journal reported earlier this month the Fed was seeking the authority.

Banks are required by law to hold a certain fraction of their deposits in reserve accounts at the Fed, but receive no interest on these deposits. Having the authority to pay interest would solve two technical headaches for the Fed. If they earned interest from the Fed, banks would have no incentive to lend out excess reserves for less. That would make the Fed’s benchmark federal-funds rate, which banks charge on overnight loans to each other, less likely to plunge below the Fed’s official target — now 2% — on days when the banking system was awash in cash. In addition, the Fed could theoretically combat the credit crunch by buying securities or extending loans without limit without causing the federal-funds rate to fall to zero, something that could fuel inflation or distort markets.

Officials from both parties have suggested they are favorably disposed to the proposal. Passage is not guaranteed, however. The controversy surrounding the Fed’s loan of $29 billion to assist in J.P. Morgan Chase & Co.’s takeover of Bear Stearns Cos. means some lawmakers may balk at any move that would benefit banks. The proposal would likely be attached to a larger and probably unrelated bill. -Greg Ip