With the FRB’s decision this week to hold on to its trillions, much has been made of the giant size the central bank has assumed since the financial crisis. But, a new proposal from the Federal Reserve Banks signals that, even if the Board starts to wean the world from quantitative easing, the Fed will get a brand-new gig: controlling the nation’s payment system.
Does this sound paranoid? Black helicopters seen circling 20th and Constitution? Not yet, but read our client report sent today on the consultative paper issued earlier this month by all of the Federal Reserve Banks on the future of the nation’s payment system. Questions are of course posed for comment, but the consultation is premised on the conclusion that retail and business customers won’t get what they need unless the Reserve Banks become the “operator, leader or catalyst” providing the services it believes private firms can’t or won’t.
Much in the consultation paper argues that the central bank should play a larger role because economic security depends on a stable, reliable payment system. True, of course, but we also depend on the electric grid, clean water, and many other underpinnings of everyday life taken for granted until they are gone. Why does the payment system warrant so grand a federal role while other essential services are left in private hands? Before the Fed advances the mission outlined in this consultation, I think it critical to answer this question, taking a hard look at why the FRB can’t just regulate where it feels the national interest is at stake and otherwise leave payment products and services in private hands. Since Dodd-Frank, the FRB has been handed formidable power over “financial market utilities,” including payment-system entities. Still not good enough? If not, why not?
One reason the Fed contemplates so large a role is the stubbornness with which the market refuses to take its hints. One loud one for decades now has been that paper checks are a big pain in the neck. True, but business and consumer payers still cling to them, in large part I think because of the clear record trail a lot of checks leaves behind. This of course results in boxes of paper the Fed must transport, banks have to image, and landfills eventually have to absorb. But, for all the ease of smart-phone technologies, users are slow to adopt them, especially for large transactions that place them at real risk. If the funds go awry the law is far less clear for disputed electronic transactions than for paper ones, a reasonable concern the Reserve Banks can’t solve simply by just taking over.
How to solve for this? Since the law won’t change any time soon, the Reserve Banks are looking to sweeten the pot. The consultation suggests a set of “incentives” banks would provide. Who pays for them is not said, but we think it’s a non-trivial question. If it’s so much in the interest of payment-system efficiency to kick the paper habit, why aren’t the chief beneficiaries of lower costs – big banks – coughing up the incentives on their own? In essence, pushing people from paper checks is social engineering – it may well make sense, but many citizens still stubbornly like to do business the way they like to do it. If private interests and pricing can’t persuade payers to change, how can the FRB do so absent a dictatorial mandate that forces change faster or in different directions than the market might otherwise choose to go?
Is the solution better protection for electronic payments through law or rule? Standardization of new technologies as the consultation in fact suggests (although it notes only that this would cost big without sticking anyone with the tab)? New security standards if cyber attack is the most pressing concern? In short, where should the central bank intervene and where should private payers and payees be left to their own devices even if the central bank thinks they’re dumb?