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Bruegel on the Target2 vs Interdistrict Settlement Account debate

The Belgium-based think take Bruegel recently linked to my guide to the Federal Reserve Interdistrict Settlement Account. In my ongoing attempt to ensure the Target2 debate doesn't founder on faulty comparisons to the Interdistrict Settlement Account, here's another post.

Although they have a better grasp on how the ISA works than most, the authors Michiel Bijlsma and Jasper Lukkezen do make an important error:

The important difference between Target 2 and ISA, however, is that in the US all Reserve Banks are owned by the federal government. This means that in the US it is possible to safeguard the integrity of the system by changing the settlement rules. This is as exciting as a game of monopoly among friends. As all Federal Reserve banks are owned by the federal government, a loss in Richmond is irrelevant when there is an equal gain in New York. In the Eurozone, however, the ECB is owned by the national governments via the national central banks, not by the European Union as a whole. When one would change the settlement rules here – for example by discounting claims – this means a transfer across countries.
In actuality, all twelve Federal Reserve district banks are owned by their member private banks. What allows the Fed to change settlement rules is not any ownership position in the Fed (they have none) but the system's constituting articles, or Federal Reserve Act, which put the preservation of the par value of US dollar-denominated banking liabilities above the necessity of the system settling.

As I pointed out in response to commenter John Wittaker here, if the Federal Reserve system was to be dissolved and there existed significant imbalances between districts, final settlement might not be guaranteed. That's because a district Fed's credit is only as good as the credit of its member private banks. If these member were asked to re-capitalize the district bank to enable it to achieve settlement, but they were unable to do so, it would cause problems.

So in that respect, Bijlsma and Lukkezen  are wrong to say that a loss in Richmond and a gain in New York is ultimately irrelevant. When all the chips are down, these imbalances represent transfers between shareholders of district Reserve banks. For instance, if the Richmond Fed failed to settle and its shareholders, including Bank of America, could not support a recapitalization of that district, then the New York Fed would have a massive loss on its hands. This would require member banks like JP Morgan to re-capitalize it. Thus, in comparing the ECB settlement mechanism to the Federal Reserve mechanism, it's not fair to say transfers do not occur - all that can be said is that these transfers are distributed across a different spectrum of actors.

Bijlsma and Lukkezen also have a similiar article here though they don't attribute to the Money View credit for the initial observation nor myself for the underlying research. They note:

Every year in April the average ISA balance over the past 12 months is calculated and netted via transfer of gold certificates between reserve banks.
This also is not entirely correct. Settlement via SOMA transfers, not gold certificates, has been the standard operating procedure since the 1970s.
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