October 4, 2025 | How a Fed Overhaul Could Eliminate the Federal Debt Crisis, Part I: The Fed’s Hidden Drain

From Scheerpost

The Federal Reserve’s independence is currently being challenged by political forces seeking to reshape its mandate. The Fed has not always been independent of Congress and the Treasury. Its independence was formalized only in 1951, with a Treasury-Federal Reserve Accord that was not a law but a policy agreement redefining the relationship of the parties. In the 1930s and 1940s, before the Fed officially became “independent,” it worked with the federal government to fund the most productive period in our country’s history. We can and should do that again.

In a Sept. 1 Substack post titled “Fed Faces Biggest Direct Challenge by a President Since JFK – and This Is a Good Thing,” UK Prof. Richard Werner shows that there is no evidence that more independent central banks deliver lower inflation. In fact, per his findings, central bank independence has no measurable impact on real economic performance, and greater central bank independence has resulted in lower economic growth.

This two-part series will probe the forces in play now to overhaul the Fed, and the feasibility of redirecting it to use its tools, including “quantitative easing,” not just to save the banks but to save the economy. Part I looks at a particularly flawed Fed policy — Interest on Reserves (IOR)  — which burdens the budget, stifles liquidity, and subsidizes banks. Then it suggests ways that eliminating IOR and reining in the Fed’s independence could solve the Treasury’s interest burden altogether.

A Unique Opportunity for a Fed Overhaul

In a paper in the Spring 2025 edition of The International Economy titled “The Fed’s New ‘Gain-of-Function’ Monetary Policy,” Treasury Secretary Scott Bessent argued that “overuse of nonstandard policies, mission creep, and institutional bloat are threatening the central bank’s monetary independence.” He called for “an honest, independent, and nonpartisan review of the entire institution and all of its activities, including monetary policy, regulatory policy, communications, staffing, and research.”

In a July 17 CNBC interview, former Fed governor Kevin Warsh went further, calling for sweeping changes in how the central bank conducts business and suggesting a policy alliance with the Treasury Department. Warsh is considered one of three or four finalists to take over as chairman after Jerome Powell at the Fed.

On August 25, Pres. Trump then sparked a political firestorm when he declared he was firing Federal Reserve Governor Lisa Cook “for cause,” citing mortgage fraud allegations from Federal Housing Finance Agency Director Bill Pulte. An NBC News report observed:

Cook’s legal battles are playing out against a broader struggle over the long-held political independence of the Federal Reserve. Trump and several of his officials, including Pulte, have attacked Powell in a months-long campaign to pressure the central bank into significantly cutting its benchmark interest rate, arguing it would stimulate the economy.

On Oct.1, the United States Supreme Court temporarily blocked the attempt to remove Governor Cook by delaying a decision on a ruling from a lower court that allowed her to stay in her position until the high court hears oral arguments in the case in January.

On Aug. 8, Fed Governor Adriana Kugler resigned, and in September, Trump pick Stephen Miran was confirmed as her replacement. The Daily Rip observed that Cook’s removal, alongside Kugler’s sudden resignation, could give Trump a 4-to-3 board majority to push for lower interest rates, in order to ease the $37 trillion national debt’s servicing costs.

But if easing the national debt servicing costs is the goal, lowering interest rates won’t do much to further it. The Fed has control only of the fed funds rate, which is short-term. Marketable securities make up the vast majority of the debt held by the public, and most of those securities are notes and bonds with fixed interest rates and maturities ranging from two to 30 years. These existing obligations continue to accrue interest at their fixed higher rates until they mature.

A More Effective Target: Interest on Reserves

While political reshuffling grabs headlines, the real target of the Administration’s moves may be that little-known Fed policy called Interest on Reserves. So argues an August 28 Heresy Financial podcast, which observes that IOR costs taxpayers $186 billion annually by paying banks a hefty interest to hold their reserves at the Fed. By eliminating IOR, the Administration could not only save this $186 billion but would release the $3.3 trillion now sitting idle in reserve accounts to other investments, most likely Treasuries, where banks could get a comparable safe return. The result would be not only to restore Fed profits to the Treasury but to lower federal borrowing costs.

The Fed says it needs IOR as a tool to control short-term interest rates, which it needs to be able to do to control inflation. By paying substantial interest on reserves, the Fed ensures that banks don’t flood markets with cash by over-lending, triggering price inflation. But the Fed managed rates through open market operations before 2008 without IOR, showing it is not essential; and it is a very costly tool.

The Crushing Financial Burden of IOR

The Federal Reserve has paid interest on bank reserve balances since 2008. As of May 2025, the Fed was paying 4.4% on $3.3 trillion in reserves, totaling $186 billion annually. These payments are deducted from the Fed’s earnings, which by law are returned to the U.S. Treasury after deducting the Fed’s costs, reducing the federal deficit.

In 2021, Fed remittances to the Treasury totaled $79 billion. In 2023, high IOR costs led to Fed losses of $114.3 billion. This not only halted remittances to the Treasury entirely, it created a net deficit to the Fed that will have to be repaid from future taxes to cover its costs. A St. Louis Fed report said it could take years before the Fed is able to once again return profits to the government.

As of the beginning of September, the national debt is at $37.4 trillion and interest payments for FY2025 are at $933 billion — the third largest category of federal expenditure after Social Security and Medicare. Lost remittances force the Treasury to borrow more at higher rates, pushing 10-year Treasury yields up to 4.2% as of September 26. A proposed bill to eliminate IOR estimates savings of $1.1 trillion over 10 years by restoring Fed profitability and remittances.

IOR has other downsides besides loss of remittances to the Treasury. It incentivizes banks to park funds at the Fed, earning over 4% risk-free, rather than using their reserves to back riskier commercial and consumer loans. Since bank lending is the source of the vast majority of the circulating money supply today, IOR reduces the money supply, constrains liquidity, and throttles lending to businesses and consumers.

Before 2008, banks lent freely, and funds held in reserve accounts were minimal. Reserves surged to $2.7 trillion by 2014 and remain high, reflecting substantially reduced lending. Commercial and industrial loans grew only 2.1% annually from 2020 to 2024 compared to 5.6% pre-2008, starving small businesses of capital.

A Subsidy for Big Banks at the Expense of Taxpayers

Critics of IOR argue that it is a subsidy for large banks, rewarding them for holding idle funds rather than fostering economic growth. Meanwhile, taxpayers face rising borrowing costs. Credit card rates averaged over 25% and 30-year fixed rate mortgages hit 6.3% in September.

IOR, which is now over 4%, sets a floor on the fed funds rate — the rate at which banks lend to each other — since they won’t lend for less than they can make at the Fed. It thus keeps borrowing costs high, contradicting the Fed’s goals of maximum employment and stable prices. Ending IOR would force banks to either lend or invest in Treasuries, aligning their incentives with economic growth.

Part 5 of a Cato Institute series called “Reforming the Federal Reserve” concludes:

At its core, the IOR policy is a government subsidy to large financial institutions. Banks now have their own risk-free savings accounts, giving them returns that are hundreds of basis points higher than what regular consumers receive on their own deposits at the very same institutions. If that isn’t bad enough, the billions that banks receive in interest payments have reduced their incentive to lend in the private market, reducing the cash available to regular Americans to borrow while flooding the banking system with trillions in reserves.

… The Fed has disbursed billions in risk-free government payments to large banks.… This policy is economically costly, threatens the Fed’s mandate to stabilize prices, and is unfair to everyday Americans.

Quantitative Easing: Another Fed Tool for Bank Rescue that Could Be Diverted to Public Investment

Eliminating IOR would produce substantial savings, but like lowering the fed funds rate, it would not fix the federal debt problem since it would not address the $10 trillion in annual debt rollovers or long-term debt. Making short-term debt cheaper could also encourage more government borrowing without curbing spending, worsening the debt cycle.

A more effective way to fix the debt permanently would be to pay it, or at least some portion of it, with government-issued money. Quantitative easing (QE), in which the Fed creates new reserves to purchase assets, is another Fed tool that today has served the banks alone. But the precedent for Fed “money-printing” has been set, and if it can be done to save the banks, it can be done to save the public. Critics say this would inflate consumer prices, but Part II of this article will counter that objection with some very successful non-inflationary precedents.

During “QE1” (2008-2010), the Fed purchased $1.25 trillion in mortgage-backed securities (MBS) — many of them distressed or illiquid — directly from banks and government-sponsored entities. This removed toxic assets from bank balance sheets and transferred them to the public. As Joseph Stiglitz observed, “We socialized losses, even as we privatized gains.” The Fed absorbed toxic assets and inflated asset prices to recapitalize Wall Street, while leaving homeowners and small businesses behind.

In a September congressional hearing, Stephen Miran pointed to a rarely discussed third mandate of the Fed. Besides price stability and maximum employment, it is required to moderate long-term interest rates. Miran argued that this mandate offers a legal and strategic opening for QE to serve public investment rather than private speculation.

But Even QE Can Provide No Federal Debt Relief Under IOR

Quantitative easing has periodically been proposed as a way to tackle the federal debt crisis. With $9.2 trillion in Treasury debt maturing annually, in four years the Fed could theoretically shift the whole $37 trillion debt onto its own books through QE and return the interest it earns on the bonds to the Treasury. The debt would still be there, but it would be an interest-free debt to a partner government agency, the Fed. Under current laws and policies, however, there are two obstacles to this solution:

1. The Primary Dealer Restriction: The Fed is not allowed to buy securities directly from the Treasury. It must buy from “primary dealers” on the open market like everyone else; and these dealers (mostly very large banks) park the funds they receive for the trade in their reserve accounts, on which the Fed pays IOR.

2. Net Loss from IOR: As of May 2025, the Fed was paying 4.4% on reserves but earning only around 3.3% on Treasury securities. So rather than returning the interest from the bonds to the Treasury, this QE maneuver would actually cause the government to lose $101 billion annually on the $9.2 trillion in bonds ($9.2 trillion × 1.1% (4.4% – 3.3%). The banks, not the Treasury, would reap the benefits.

A Call for Reform

Changing these rules requires legal changes or a cooperative Fed board, which faces resistance from the banking lobby profiting from IOR’s $186 billion windfall. The Fed has issued trillions of dollars in reserves to save the banks, its real constituents. Would it do that to save the government? Only if its interests were aligned, as they were in the 1930s and 1940s.

Either the independence of the Fed needs to be curbed or the Treasury needs to issue money directly, as Abraham Lincoln did. As will be shown in Part II of this article, this solution has substantial successful precedent both in the U.S. and abroad; it need not create inflation, and it is the monetary “secret sauce” of our largest competitor, China. By directing central bank liquidity toward infrastructure and industrial policy, the People’s Bank of China stabilizes prices, supports employment, and reduces long-term borrowing costs. The question is not whether QE can serve the public, but whether the Fed will choose to wield its mandate for that purpose.

Central banks must be accountable not just to their banking constituents but to Congress and the people they represent. If we’re legalizing QE for Wall Street, then it’s time to fund QE for Main Street.

Ellen Brown October 4th, 2025

Posted In: Web of Debt

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