The Fed Versus TNB

Today’s show is a fascinating story about industry insiders who are challenging the state of the banking industry. 

Last week I published an episode called "Not worth a Continental". If you have not listened to that episode, I suggest you stop today’s show and go listen to that earlier episode first. Today’s show will make so much more sense if you do.

The players in the story are James McAndrews, former research director for the New York Federal Reserve Bank., And the Federal Reserve itself on the other side of the table.

The Wall Street Journal reported on Friday that The Federal Reserve is pushing back against a new private bank that is suing the central bank for access to its services. 

The New York Fed filed a motion last Friday in U.S. federal court asking the court to dismiss a lawsuit filed against it last August by TNB USA Inc., a private bank formed in 2017 by James McAndrews, the New York Fed’s former research director. 

TNB, is a bank chartered in Connecticut, and they sued the New York Fed for taking no action on its request for an interest-bearing account at the central bank like those that member banks have, and which are necessary to obtain Fed services. 

Under its business model, TNB would accept deposits from large investors and park the money on the Fed’s books to earn interest. 

The Fed would pay TNB the same rate it pays banks on the money, called excess reserves, they hold at the central bank. TNB would pay a slightly lower rate of interest to its depositors, pocketing the difference while still enabling its depositors to earn more than they might at a conventional bank. 

The interesting part here is that TNB’s model isn’t novel at all. It’s called arbitrage, and its been at the foundation of the banking industry since the beginning of banking. Loan money at a higher rate, and give deposit interest to depositors at a lower rate. The real issue is that the Fed is loaning money to member banks and then taking back the excess reserves as deposits. 

TNB is a private bank and not a Fed member bank. Therefore it doesn’t automatically get to take advantage of all the same privileges that member banks do. It’s a closed club. It took an industry insider, James McAndrews to expose the issue and to try and take advantage of the system that was put in place.

Think about it. If you could put money on deposit with the Fed, and earn virtually the same rate of interest as you would with US Treasury bills with the zero risk of the Fed defaulting, would you make that investment as a place to park cash?

If you put your money at Wells Fargo or Bank of America, you’re going to get 1.44% on your money and you’re locked into to a certificate of deposit. For something even more restrictive, you can get 2.3% at one of the major banks. But imagine if you could get 2.5% and park your money at the Fed and have full liquidity?

The point of today’s episode is that there are multiple sets of rule books. If you’re going to be playing the game of finance, recognize that context is very important. It determines which set of rules will apply to you. If you change your context, you can change the game you’re playing altogether. Most people aren’t playing the game because they don’t know the rules.