Record Fed Profits Paid to Treasury

The Board of Governors recently announced a record $78.4 billion of Reserve bank earnings paid to the Treasury (and taxpayers) in 2010, up from a record $47.4 billion in 2009. These record earnings come from the growth in assets related to recent Fed policy. To the extent that outstanding Treasury debt is purchased by the Fed, the burden of interest payments on the public debt is reduced almost proportionally.

As usual, serial Fed bashers are stretching to find ways to criticize the Fed. This time, the criticism is directed at the fiscal windfall which is a by-product of its monetary policy. One such basher, a former Fed official who should know better, said on Cable TV that the Fed was broke or near broke because a rise in interest rates could easily wipe out the Fed’s capital if its assets were marked to market, which should be done in his opinion.

First, there is no need for the Fed to mark to market since its assets are not held for trading and can easily be held to maturity or recovery if necessary. Second, the Fed’s liabilities are mainly the required reserves of the banking system not subjecting to withdrawal except as banking assets shrink. Fed liabilities are not hot money. Third, the Fed’s capital is required to be held by member banks and is subject to calls that would double its size if necessary. In other words, the Federal Reserve and other central banks are unique institutions and the usual rules and ratios don’t apply.

Regular banks, to some degree, still “borrow short and lend long.” They are vulnerable to losing deposits and faster than they can liquidate assets; so their capital is at risk. The deposit liabilities of Federal Reserve Banks, however, are the reserve deposits that banks are required to maintain at the Fed as a percentage of their own deposit liabilities. The excess reserve component has risen in the past two years, but mostly they are required reserves. The Fed’s ability now to pay interest on reserves, including excess reserves, gives it a tool, if needed, to incent even excess reserves to remain. In other words, those who hold the Fed’s liabilities are compelled to do so.

The Fed’s capital account is also unique. When banks become  members of the Federal Reserve System, which is mandatory for national banks and voluntary for state banks, they have to purchase stock in their local Federal Reserve Bank equal to six percent of their own capital and surplus. Three percent of that is paid in to the Fed and the other three percent is subject to call by the Fed. In other words, if needed, the Fed could double its capital level simply by calling the second half.

In summary, central banks are unique and aren’t subject to the same liquidity crises as private banks. The expansion of Fed assets could become overdone and stoke inflation. It will certainly create a tricky exit situation when the time comes. In the meantime, one result of it’s asset expansion is fiscal relief for the Treasury and the taxpayer. Let’s not look a gift horse in the mouth.

Comments (5)

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  1. Jon says:

    Are you kidding me? I think this statement was a mistake. “The excess reserve component has risen in the past two years, but mostly they are required reserves.” “Mostly they are required reserves,” really? Maybe I am misinterpreting what you are saying. But please look at the following graphs:

    http://research.stlouisfed.org/fred2/series/EXCRESNS?cid=123

    http://research.stlouisfed.org/fred2/series/REQRESNS?cid=123

  2. EHROSEN says:

    Thank you for again sharing inside baseball and making it understandable. Two follow up questions are begged by this piece, at least two :)
    1. Then why the secrecy? Why not show what is on the balance sheet? Pat explanations understood but if the government is buying unprecedented assets, isn’t unprecedented access warranted?
    2. Many suspect the Fed has purchased some “assets” that are worth less or worthless. Won’t this lower the value of the dollar vs. other currencies when it eventually is brought to light, if true of course?

  3. Dave Narby says:

    “The expansion of Fed assets could become overdone and stoke inflation. It will certainly create a tricky exit situation when the time comes.”

    Indeed.

    “If a country could simply buy its own debt with zero downside, I say we should have been doing this all along.” – Greg Hunter, USAWatchdog.com

    Yeah, this will end well, for sure… : p

  4. Or is it that the Fed cannot be insolvent because it A) writes its own accounting rules and B) just rewrote them to turn a negative capital balance into a credit against the “money” it would have paid to the Treasury as these awesome “profits” you’re talking about?

    http://www.jrdeputyaccountant.com/2011/01/dirty-fed-quietly-rewrites-accounting.html

    I wish I had that same sort of power in my checking account, I’d be rich!

    Frankly I thought you were smarter than to make excuses for this kind of behavior, Bob.

  5. W.C. Varones says:

    Can I charge a case of Alpo for my Grandma to a negative liability account at the Treasury?

    She’s really digging that food inflation while she gets 0.5% on her savings.