Believe those who are seeking the truth. Doubt those who find it. Andre Gide

Thursday, April 22, 2010

Fed Makes $47.4B Profit for U.S. Taxpayers

The Federal Reserve System on Wednesday released the 2009 annual comparative financial statements for the Reserve Banks, the limited liability companies (LLCs) that were created to respond to strains in financial markets, and the Board of Governors; see here.

In a remark that may have been directed to those concerned about "transparency" at the Fed, Chairman Ben Bernanke said:

"I am pleased that an independent auditor has found that our financial statements present fairly, in all material respects, the financial position of the Federal Reserve. The information disclosed in the 2009 financial statements reaffirms our commitment to transparency and to the responsible stewardship of public resources."

The annual financial statements include information about the assets held by each of the consolidated LLCs (limited liability companies, known as Maiden Lane I, II, and III). The statements also contain summaries of the associated credit and market risk for each significant holding.

The Reserve Banks’ comprehensive income increased $17.9 billion over the previous year to $53.4 billion….The increase was primarily attributable to interest earnings on the Federal agency and GSE MBS holdings (and was) partially offset by a decrease of $3.8 billion in realized gains on the sale of Treasury securities and a decrease of $2.8 billion in interest income on loans to depository institutions.

The Reserve Banks transferred $47.4 billion of their $53.4 billion in comprehensive income to the U.S. Treasury in 2009, a $15.7 billion or 50 percent increase from the amount transferred in 2008.

Here is an excerpt from a related NY Times article:

Along with financial statements for the Fed’s board of governors in Washington and the 12 Fed district banks, the Fed released details about the assets held by five limited liability companies that were created by the Federal Reserve Bank of New York in response to the crisis.

Three of those companies, known as Maiden Lane I, II and III, were created to hold troubled assets, including mortgage-backed securities and
collateralized debt obligations, acquired as a result of the government-brokered sale of Bear Stearns to JPMorgan Chase in March 2008 and the takeover of the American International Group, the stricken insurance giant, that September.

The Fed expects to recover the full value of the loans made to those special entities and does not expect any loss to taxpayers from them, senior Fed officials said in a conference call.

If the Fed does end up avoiding losses on these enterprises, then perhaps there is something to be said about the desirability of having a central bank operate as lender of last resort. (I would not have thought so even a year ago).


  1. David,

    The problem I see is that the news is too good. Is there a danger that good performance will lead to a situation in which risky debt becomes an acceptable form of debt that banks can sell to the Fed in exchange for dollars? This may have the consequence of raising the riskiness of the Fed banks themselves. Although, there may be some positive unintended consequences. I'll have to think about it some more.

  2. But even if the fed does 'make money' on these loans, does that compensate for the increased moral hazard risk and impact?

    Is not the fed's success an invitation to more risky behaviour?

  3. Westslope:

    Moral hazard risk implies taking on excessively risky bets; bets that do not pay off in a downturn.

    The market was pricing these bets as if they would not pay off. The Fed stepped in and purchased these bets (or used the bets as collateral for loans).

    And lo and behold, the bets paid off! So were these excessively risky bets to begin with?

    In any case, pity the poor Fed. If it were to lose money, it will be criticized for recklessness. If it makes money, it is accused of promoting risk.

    Perhaps this is the primary role of the Fed: to serve as the lightening rod for discontent?

  4. Hi, thanks for the article!

    I have a question. According to a January article in the Washington Post, "By the end of 2009, the Fed owned $1.8 trillion in U.S. government debt and mortgage-related securities...." So when the Fed pays the US Treasury almost $48 billion in profits...I'm assuming that the Fed is making interest off of the US debt that it holds, right? 6% interest on that debt would return (roughly) $10 billion.

    Please don't label me "malcontent," I just want to know how I should feel about this: do we consider it profit if the Fed is simply returning interest income it made from the US Government?

    If the Federal government is a proxy for citizens (as your article's title suggests), then a large portion of the payment isn't "profit," but rather in effect simply an interest-free loan to the government, yes?

    (Obviously free money from banks, loaned to the federal government at 0%, is quite nice. Just wondering if we can really call the reimbursement of debt interest money "profit")


    PS. Looking back at the washington post quote, it says 1.8 trillion in gov't debt AND mortgage-backed securities, so I guess I don't know the real figure for just gov't debt...but my question stands. Cheers!

  5. Michael:

    Yes, the Fed generates interest income from the assets it holds on its balance sheet. In normal times, these assets consist primarily of short term US treasuries. The current interest rate on these assets is very low (one year treasuries are yielding less than 0.5%).

    The big increase in Fed profit for last year seems to be related to its Maiden Lane investments. In other words, the profit it generated did not come from the government, it came as result of its intervention in the private sector.

    In normal times, the Fed makes a "profit" off the interest it earns from US treasuries. Even if this interest rate is zero, it makes a profit on the new money it creates (seigniorage). From the point of view of the Fed, this is "profit." But don't get hung up on labels here. The interest income earned by the Fed and paid by the Treasury washes out, so there is no "profit" for the taxpayer. However, the new money the Fed creates (seigniorage) and remits to the Treasury is profit; indeed, it constitutes tax revenue for the Treasury.

    Of course, we are not in normal times. The majority of the Fed's assets are now in the form of income-generating MBS. The Fed is making a profit off of these; although whether it continues to do so remains to be seen.

    Does this answer your question?

  6. It does; I grossly over-estimated the interest rate of the T-bills, so my argument is pedestrian at best.


  7. This overlooks the question of where the profits NOT emitted to the treasury go? Whose pockets? Who owns the "Federal" Reserve?

    Also, the US government owes the Federal Reserve almost half a trillion dollars and pays INTEREST to the Federal Reserve. At most, this remittance to the treasury barely covers the interest payments the government has to make to the Fed.

    Also, if you consider that the federal reserve has lent trillions to banks who then charge our citizenry interest on those loans, there is no question it's a negative influence. i.e. if you want a mortgage, the fed prints the money hands it to your bank, and charges you interest on it, despite the fact it was the citizenry's money to begin with.