The Fed pays banks $700 million a day and the debate erupts

The Fed pays banks $700 million a day for their reserves

The Federal Reserve has stopped being profitable. It no longer sends billions to the US Treasury and instead pays out nearly $700 million a day to banks in reverse repos and interest on reserves. The figure, spread through a social media post, has reignited a debate that has been simmering for years: how much does it cost to sustain the financial scaffolding built after 2008, and for how long can the bill be paid?

The number is no accounting anecdote. It is the symptom of a model in which the central bank pays institutions interest for parking money instead of lending it. With official rates at levels not seen in decades, that remuneration has become a silent drain that, according to circulating estimates, equals the cost of financing every program designed to keep the system standing. The issue matters because it strikes at the dollar's lifeline: if the issuer loses money, someone eventually foots the bill.

Why the Fed went from earning to paying

For years, the Federal Reserve bought sovereign and agency debt on a massive scale. Those bonds generated interest that, once expenses were covered, flowed back to the Treasury. It was a tidy business: the central bank financed the state and handed back a cut. The mechanism worked while rates were pinned to the floor and bond portfolios bought at high prices yielded enough.

The turning point came with rate hikes. The Fed now remunerates the reserves banks deposit with it at a rate of around 4% and also pays for reverse repos, the instrument it uses to absorb liquidity from the market. The result is a balance sheet in the red that, according to the figure that sparked the discussion, translates into nearly $700 million a day. Some argue that, projected over a year, that figure comfortably exceeds the cost of any public stimulus program.

The paradox is subtle: the central bank that prints money to prop up the system now pays banks not to use it. And it does so while the Treasury keeps issuing debt on a massive scale to cover its own imbalances. Two holes feeding each other.

The calculation that explains why nobody wants to sell old bonds

The problem is not the Fed's alone. Anyone holding bonds bought when rates were rock bottom is trapped. The example doing the rounds is devastating: whoever bought ten-year debt at 0.5% and has spent five years collecting ridiculous coupons faces another five years of the same perversos yield. If they tried to sell that paper today, they would have to swallow a brutal loss, because buyers demand the current, far higher return.

That liquidity trap affects banks, funds and insurers around the world. The full breakdown, item by item, shows a discount that lays bare the scale of the mess. Nobody wants to book losses on their balance sheets, so everyone looks the other way and hopes rates fall before the rope pulls too tight.

Hence the system rests on an accounting fiction: assets are worth on the books what they cost, not what they are worth today. If anyone demanded real valuations, alarms would go off and additional collateral would be called for. Nobody wants that.

Who foots the bill when money loses value

The discussion quickly turns to who pays. The sectors that always end up paying are the same ones: salaried workers and those on fixed incomes who watch their purchasing power evaporate while financial assets inflate. An example repeated in the conversation: in 2011 a room in a university town cost 250 euros; today, in the same area, it does not go below 700. Wages, meanwhile, have not kept pace.

Some argue the impoverishment is massive and that the official narrative's achievement is keeping part of the population from noticing. Others reply that the system holds because the big holders of US debt —China among them— have no interest in seeing the dollar lose value. It is the old mutual hostage theory: everyone trapped, nobody willing to let go first.

The question hanging in the air is what happens the day creditors want to be paid in tangible goods rather than in bills that lose value by the minute. The most common answer is that nothing will happen, because the United States has a printing press and an aircraft carrier. As long as that holds true, the game goes on.

What could happen if rates don't fall

The most unsettling scenario is not a sudden collapse but a decade of slow purging. High rates for a prolonged period would force latent losses to be recognized, institutions to be recapitalized and public spending to be cut. Some speak of a mass extinction event comparable to the dot-com bust or the housing bubble, but multiplied. The comparison falls short, they say, because this time the damaged asset is money itself.

Against that, the skeptical camp reminds us that the apocalypse has been announced for years without a date. That the system is a ponzi is one thing; that it collapses tomorrow is another. The purge will come when it suits those in charge, not when the charts say so.

Given all this, the prudent bet is that rates ease before the Fed's daily bill becomes a first-order political problem. If they don't, the debate will stop being economic and become something else entirely.