No, Xcel Energy does not make a lot of money from the “float” of interim increased customer payments it receives between the time it files for a large rate increase — as it did this week — and when the state Public Utilities Commission grants a smaller one that necessitates refunding of the excess received over this time gap.
The law specifies that Xcel must pay interest on any excess collected, so the utility is not out making money with their customers’ money.
It is a great question, however, asked by an astute reader in reaction to the latest in a series of large increase requests filed by Xcel that inevitably get pared back by the PUC.
If there was no requirement to pay interest, there would be an enormous incentive for any regulated utility to file excessive interim rate increase requests, knowing that administrative wheels grind slowly, with up to a year for a final determination. Yes, the utility would have to pay back the overcharge in the form of lower future bills to customers, but having even temporary control of someone else’s money can confer sizeable gains. When that happens, it is called “float.” It is not an important concept in theoretical economics, but one with important implications in the real world.
Travelers’ checks are perhaps the classic example of float. Before the advent of instant verification electronic payments systems, paying for meals, lodging and other purchases far from home often was difficult. And carrying cash was dangerous. Enter the travelers’ check, a means of payment guaranteed by well-known companies like American Express.
The customer had to pay for these checks up front from his or her local bank. In that sense, the checks were a predecessor of a stored-value card or a pre-paid charge card. The selling bank would send the money to American Express, which would be able to use it until the checks were presented for payment.
As the checks were used to make purchases, accepting merchants would deposit them with their banks that would in turn clear them with the issuer, American Express. But in the interim between the time the selling bank remitted money and the time an accepting bank presented them for payment, American Express had free funds to invest.
Weeks or months often passed between the time consumers purchased the checks and when they were redeemed. This was accentuated by the fact that with a small amount left after one trip, some people would just “save them for the next trip,” rather than cashing them in. And some got lost or left in some inner pocket of a suitcase. All this constituted interest-free loans to American Express.
Sometimes float worked in favor of the consumer. Decades ago, while working in Peru, I frequently traveled to regional cities. The national government ran a chain of “Hotels for Tourists” in places deemed as not having adequate private-sector ones. This chain accepted only one credit card, Diner’s Club. When I charged a room and meals on my U.S. Diner’s Club card, it would not appear on my statement until five months afterward. In the meantime, my employer would reimburse my travel expense in cash the day I turned in my receipts. Since inflation in Peru was running 70 percent a year at the time, this was more than just an interest-free loan from the Peruvian Ministry of Tourism to me.
On a much smaller scale, when check clearing was slower in past decades, one could buy merchandise with a check that might not clear for four days or more. The purchaser enjoyed the new possession, but still had the money. The implicit transfer was minor since checking accounts did not pay interest, although many people took advantage of the float and did not deposit enough money into the account to cover the check until just before it was expected to hit.
In a more modern setting, when one pays for something with a credit card and owes no interest if you pay when your monthly bill comes due a few weeks later, you have been enjoying float at the expense of the merchant and the card-issuing bank. But few people pay entirely when due, and the interest earned on outstanding amounts is sufficient to compensate the bank for the cost of float.
These are interesting anecdotes, but aside from specialized firms like travelers check issuers, how could float have much economic importance? After all, modern electronic payment systems have reduced clearing delays to seconds or minutes instead of days.
It can still matter when the amounts involved are enormous, even if the delays a short. Float essentially results from a loan forced by administrative delays. In almost all cases, there is no collateral for such “loans.” If a given payment is defaulted, the payee has to seek normal redress in the judicial system. This is no different than when someone writes a check without sufficient funds.
However, in transactions between large banks, especially those involving short-term money market loans called repurchase agreements or trading of foreign currency, one institution can owe another hundreds of millions or even billions for a matter of a few hours. Under normal circumstances, this is not a problem, but it can become an acute one when one of the firms is failing.
In 1974, Herstatt Bank, based in Cologne, Germany, was insolvent as a result of bad derivative trades and was closed at the end of the business day by German regulators. That day it had bought Deutschmarks from international banks for which it was to pay in dollars by the close of business in New York. But the time zones vary by six hours. Herstatt had received its marks but had not yet handed over dollars.
That incident motivated improvements in interbank clearing systems to reduce such risk. But these systems are not perfect, and in the more recent failures of Bear Sterns, Lehman Brothers and MF Global, the fear of losing hundreds of millions in extremely short-term float led counterparties to freeze up. If a situation like that of Lehman had gotten out of hand, this fear of loss on what is essentially “float,” could cause markets to seize up entirely.
Don’t say it will never happen.