On July 21, 2011, we penned a commentary titled “Can the Fed Make a Profit for the Taxpayer?” (https://www.cumber.com/market-commentary/can-fed-make-profit-taxpayer July 21, 2011). We argued that, notwithstanding statements from Chairman Bernanke that the Fed would make a profit and that the proceeds remitted to the Treasury would help to reduce the deficit, the Fed cannot and did not make a “profit” on its security holdings. Now that the Fed holds a large portfolio of longer-term, low-yielding assets earning an average of about 2% at the same time that it is paying 4.8% on bank reserves, it is worth looking again at Fed accounting and government accounting and how misleading it can be on several fronts, especially given what has happened to Silicon Valley Bank. The key to understanding the numbers lies in recognizing that the Fed is not a private entity but is rather part of the government, and hence, analysis of the implications of the Fed’s balance sheet and income must be consolidated into the government’s balance sheet and income to understand the true impact of the interactions between the Fed and Treasury on the US taxpayer.
Those who argue that Fed remittances are a return of profit to the Treasury on its portfolio are incorrectly viewing the Fed as a private entity that earns income on its portfolio of Treasuries and mortgage securities, deducts its expenses, and returns the so-called “profit” to the Treasury. As will be shown, this is not the proper way to view remittances. The public confusion on this issue is fueled by two faulty and misleading government accounting conventions. The first convention is that the Fed’s security holdings are considered by the Treasury as “securities held by the public” instead of as intra-governmental security holdings. In addition, the National Income and Product Accounts (NIPA) treat Federal Reserve Banks as part of the domestic financial system. This makes it seem as if the Fed is a private firm rather than part of the government. The second convention is that remittances are incorrectly scored as revenue by the Treasury instead of as a net expense. To understand why this treatment of the Fed’s assets and remittances is really an accounting shell game, it is necessary to go a bit deeper into the accounting.
Put simply, the Treasury securities on the Fed’s balance sheet are also a liability of the Treasury, and from the perspective of the government’s consolidated balance sheet, the two exactly offset each other. Now, the Treasury pays interest to the Fed on its Treasury holdings, which is an expense to the Treasury. The Fed uses the interest earned to pay interest on reserves and to cover its operating expenses, and then it returns the unused expense money back to the Treasury. That internal governmental return on the Treasury’s interest expense is not now magically the Fed’s profit. Rather, it is the return of a portion of an expense of the Treasury. It is like you’re giving a dependent child a check for $1000, which is used to cover $50 of school expenses. When the remaining $950 is returned, you, as a family, are not suddenly $950 richer. If the interest expense and remittance transactions were settled on a net basis, there would always be a net transfer of funds to the Fed equaling its operating expenses; that is, in our example, your family has $50 less than before.
It is only a quirk of government accounting that improperly permits the Treasury to treat the return of an unused expense as income for budget purposes. The issue has taken a new turn now that the interest earned on the Fed’s low-yielding Treasuries (which are booked at par and not market) is less than the 4.9% interest costs that the Fed is currently paying on bank reserves. Since the difference is negative, the Fed will be reporting an operating loss. Normally, a loss would result in a reduction in the Fed’s paid-in capital, which presently stands at about $40 billion, and surplus is about $9 billion. But the Fed has precious little capital relative to over $8 trillion of liabilities. In addition, Congress tapped the Fed’s surplus to fund the Highway Transportation Bill, which was capped at $10 billion in 2016. A deal was struck with the Treasury stipulating that, should losses occur that would otherwise reduce the Fed’s capital, the Fed would instead create a negative asset account into which those losses would be booked. There would be no remittances until there is sufficient positive net income to extinguish the negative asset account. So in this case, the Treasury again will be covering the Fed’s losses by pushing them into the future in the hope that the Fed’s finances will turn around. We will see the losses accumulate and can compare them against the Fed’s paid-in capital and surplus to determine whether the Fed is in a negative capital position or not.
On July 21, 2011, we penned a commentary titled “Can the Fed Make a Profit for the Taxpayer?” (https://www.cumber.com/market-commentary/can-fed-make-profit-taxpayer July 21, 2011). We argued that, notwithstanding statements from Chairman Bernanke that the Fed would make a profit and that the proceeds remitted to the Treasury would help to reduce the deficit, the Fed cannot and did not make a “profit” on its security holdings. Now that the Fed holds a large portfolio of longer-term, low-yielding assets earning an average of about 2% at the same time that it is paying 4.8% on bank reserves, it is worth looking again at Fed accounting and government accounting and how misleading it can be on several fronts, especially given what has happened to Silicon Valley Bank. The key to understanding the numbers lies in recognizing that the Fed is not a private entity but is rather part of the government, and hence, analysis of the implications of the Fed’s balance sheet and income must be consolidated into the government’s balance sheet and income to understand the true impact of the interactions between the Fed and Treasury on the US taxpayer.
Those who argue that Fed remittances are a return of profit to the Treasury on its portfolio are incorrectly viewing the Fed as a private entity that earns income on its portfolio of Treasuries and mortgage securities, deducts its expenses, and returns the so-called “profit” to the Treasury. As will be shown, this is not the proper way to view remittances. The public confusion on this issue is fueled by two faulty and misleading government accounting conventions. The first convention is that the Fed’s security holdings are considered by the Treasury as “securities held by the public” instead of as intra-governmental security holdings. In addition, the National Income and Product Accounts (NIPA) treat Federal Reserve Banks as part of the domestic financial system. This makes it seem as if the Fed is a private firm rather than part of the government. The second convention is that remittances are incorrectly scored as revenue by the Treasury instead of as a net expense. To understand why this treatment of the Fed’s assets and remittances is really an accounting shell game, it is necessary to go a bit deeper into the accounting.
Put simply, the Treasury securities on the Fed’s balance sheet are also a liability of the Treasury, and from the perspective of the government’s consolidated balance sheet, the two exactly offset each other. Now, the Treasury pays interest to the Fed on its Treasury holdings, which is an expense to the Treasury. The Fed uses the interest earned to pay interest on reserves and to cover its operating expenses, and then it returns the unused expense money back to the Treasury. That internal governmental return on the Treasury’s interest expense is not now magically the Fed’s profit. Rather, it is the return of a portion of an expense of the Treasury. It is like you’re giving a dependent child a check for $1000, which is used to cover $50 of school expenses. When the remaining $950 is returned, you, as a family, are not suddenly $950 richer. If the interest expense and remittance transactions were settled on a net basis, there would always be a net transfer of funds to the Fed equaling its operating expenses; that is, in our example, your family has $50 less than before.
It is only a quirk of government accounting that improperly permits the Treasury to treat the return of an unused expense as income for budget purposes. The issue has taken a new turn now that the interest earned on the Fed’s low-yielding Treasuries (which are booked at par and not market) is less than the 4.9% interest costs that the Fed is currently paying on bank reserves. Since the difference is negative, the Fed will be reporting an operating loss. Normally, a loss would result in a reduction in the Fed’s paid-in capital, which presently stands at about $40 billion, and surplus is about $9 billion. But the Fed has precious little capital relative to over $8 trillion of liabilities. In addition, Congress tapped the Fed’s surplus to fund the Highway Transportation Bill, which was capped at $10 billion in 2016. A deal was struck with the Treasury stipulating that, should losses occur that would otherwise reduce the Fed’s capital, the Fed would instead create a negative asset account into which those losses would be booked. There would be no remittances until there is sufficient positive net income to extinguish the negative asset account. So in this case, the Treasury again will be covering the Fed’s losses by pushing them into the future in the hope that the Fed’s finances will turn around. We will see the losses accumulate and can compare them against the Fed’s paid-in capital and surplus to determine whether the Fed is in a negative capital position or not.
On July 21, 2011, we penned a commentary titled “Can the Fed Make a Profit for the Taxpayer?” (https://www.cumber.com/market-commentary/can-fed-make-profit-taxpayer July 21, 2011). We argued that, notwithstanding statements from Chairman Bernanke that the Fed would make a profit and that the proceeds remitted to the Treasury would help to reduce the deficit, the Fed cannot and did not make a “profit” on its security holdings. Now that the Fed holds a large portfolio of longer-term, low-yielding assets earning an average of about 2% at the same time that it is paying 4.8% on bank reserves, it is worth looking again at Fed accounting and government accounting and how misleading it can be on several fronts, especially given what has happened to Silicon Valley Bank. The key to understanding the numbers lies in recognizing that the Fed is not a private entity but is rather part of the government, and hence, analysis of the implications of the Fed’s balance sheet and income must be consolidated into the government’s balance sheet and income to understand the true impact of the interactions between the Fed and Treasury on the US taxpayer.
Those who argue that Fed remittances are a return of profit to the Treasury on its portfolio are incorrectly viewing the Fed as a private entity that earns income on its portfolio of Treasuries and mortgage securities, deducts its expenses, and returns the so-called “profit” to the Treasury. As will be shown, this is not the proper way to view remittances. The public confusion on this issue is fueled by two faulty and misleading government accounting conventions. The first convention is that the Fed’s security holdings are considered by the Treasury as “securities held by the public” instead of as intra-governmental security holdings. In addition, the National Income and Product Accounts (NIPA) treat Federal Reserve Banks as part of the domestic financial system. This makes it seem as if the Fed is a private firm rather than part of the government. The second convention is that remittances are incorrectly scored as revenue by the Treasury instead of as a net expense. To understand why this treatment of the Fed’s assets and remittances is really an accounting shell game, it is necessary to go a bit deeper into the accounting.
Put simply, the Treasury securities on the Fed’s balance sheet are also a liability of the Treasury, and from the perspective of the government’s consolidated balance sheet, the two exactly offset each other. Now, the Treasury pays interest to the Fed on its Treasury holdings, which is an expense to the Treasury. The Fed uses the interest earned to pay interest on reserves and to cover its operating expenses, and then it returns the unused expense money back to the Treasury. That internal governmental return on the Treasury’s interest expense is not now magically the Fed’s profit. Rather, it is the return of a portion of an expense of the Treasury. It is like you’re giving a dependent child a check for $1000, which is used to cover $50 of school expenses. When the remaining $950 is returned, you, as a family, are not suddenly $950 richer. If the interest expense and remittance transactions were settled on a net basis, there would always be a net transfer of funds to the Fed equaling its operating expenses; that is, in our example, your family has $50 less than before.
It is only a quirk of government accounting that improperly permits the Treasury to treat the return of an unused expense as income for budget purposes. The issue has taken a new turn now that the interest earned on the Fed’s low-yielding Treasuries (which are booked at par and not market) is less than the 4.9% interest costs that the Fed is currently paying on bank reserves. Since the difference is negative, the Fed will be reporting an operating loss. Normally, a loss would result in a reduction in the Fed’s paid-in capital, which presently stands at about $40 billion, and surplus is about $9 billion. But the Fed has precious little capital relative to over $8 trillion of liabilities. In addition, Congress tapped the Fed’s surplus to fund the Highway Transportation Bill, which was capped at $10 billion in 2016. A deal was struck with the Treasury stipulating that, should losses occur that would otherwise reduce the Fed’s capital, the Fed would instead create a negative asset account into which those losses would be booked. There would be no remittances until there is sufficient positive net income to extinguish the negative asset account. So in this case, the Treasury again will be covering the Fed’s losses by pushing them into the future in the hope that the Fed’s finances will turn around. We will see the losses accumulate and can compare them against the Fed’s paid-in capital and surplus to determine whether the Fed is in a negative capital position or not.
On July 21, 2011, we penned a commentary titled “Can the Fed Make a Profit for the Taxpayer?” (https://www.cumber.com/market-commentary/can-fed-make-profit-taxpayer July 21, 2011). We argued that, notwithstanding statements from Chairman Bernanke that the Fed would make a profit and that the proceeds remitted to the Treasury would help to reduce the deficit, the Fed cannot and did not make a “profit” on its security holdings. Now that the Fed holds a large portfolio of longer-term, low-yielding assets earning an average of about 2% at the same time that it is paying 4.8% on bank reserves, it is worth looking again at Fed accounting and government accounting and how misleading it can be on several fronts, especially given what has happened to Silicon Valley Bank. The key to understanding the numbers lies in recognizing that the Fed is not a private entity but is rather part of the government, and hence, analysis of the implications of the Fed’s balance sheet and income must be consolidated into the government’s balance sheet and income to understand the true impact of the interactions between the Fed and Treasury on the US taxpayer.
Those who argue that Fed remittances are a return of profit to the Treasury on its portfolio are incorrectly viewing the Fed as a private entity that earns income on its portfolio of Treasuries and mortgage securities, deducts its expenses, and returns the so-called “profit” to the Treasury. As will be shown, this is not the proper way to view remittances. The public confusion on this issue is fueled by two faulty and misleading government accounting conventions. The first convention is that the Fed’s security holdings are considered by the Treasury as “securities held by the public” instead of as intra-governmental security holdings. In addition, the National Income and Product Accounts (NIPA) treat Federal Reserve Banks as part of the domestic financial system. This makes it seem as if the Fed is a private firm rather than part of the government. The second convention is that remittances are incorrectly scored as revenue by the Treasury instead of as a net expense. To understand why this treatment of the Fed’s assets and remittances is really an accounting shell game, it is necessary to go a bit deeper into the accounting.
Put simply, the Treasury securities on the Fed’s balance sheet are also a liability of the Treasury, and from the perspective of the government’s consolidated balance sheet, the two exactly offset each other. Now, the Treasury pays interest to the Fed on its Treasury holdings, which is an expense to the Treasury. The Fed uses the interest earned to pay interest on reserves and to cover its operating expenses, and then it returns the unused expense money back to the Treasury. That internal governmental return on the Treasury’s interest expense is not now magically the Fed’s profit. Rather, it is the return of a portion of an expense of the Treasury. It is like you’re giving a dependent child a check for $1000, which is used to cover $50 of school expenses. When the remaining $950 is returned, you, as a family, are not suddenly $950 richer. If the interest expense and remittance transactions were settled on a net basis, there would always be a net transfer of funds to the Fed equaling its operating expenses; that is, in our example, your family has $50 less than before.
It is only a quirk of government accounting that improperly permits the Treasury to treat the return of an unused expense as income for budget purposes. The issue has taken a new turn now that the interest earned on the Fed’s low-yielding Treasuries (which are booked at par and not market) is less than the 4.9% interest costs that the Fed is currently paying on bank reserves. Since the difference is negative, the Fed will be reporting an operating loss. Normally, a loss would result in a reduction in the Fed’s paid-in capital, which presently stands at about $40 billion, and surplus is about $9 billion. But the Fed has precious little capital relative to over $8 trillion of liabilities. In addition, Congress tapped the Fed’s surplus to fund the Highway Transportation Bill, which was capped at $10 billion in 2016. A deal was struck with the Treasury stipulating that, should losses occur that would otherwise reduce the Fed’s capital, the Fed would instead create a negative asset account into which those losses would be booked. There would be no remittances until there is sufficient positive net income to extinguish the negative asset account. So in this case, the Treasury again will be covering the Fed’s losses by pushing them into the future in the hope that the Fed’s finances will turn around. We will see the losses accumulate and can compare them against the Fed’s paid-in capital and surplus to determine whether the Fed is in a negative capital position or not.
On July 21, 2011, we penned a commentary titled “Can the Fed Make a Profit for the Taxpayer?” (https://www.cumber.com/market-commentary/can-fed-make-profit-taxpayer July 21, 2011). We argued that, notwithstanding statements from Chairman Bernanke that the Fed would make a profit and that the proceeds remitted to the Treasury would help to reduce the deficit, the Fed cannot and did not make a “profit” on its security holdings. Now that the Fed holds a large portfolio of longer-term, low-yielding assets earning an average of about 2% at the same time that it is paying 4.8% on bank reserves, it is worth looking again at Fed accounting and government accounting and how misleading it can be on several fronts, especially given what has happened to Silicon Valley Bank. The key to understanding the numbers lies in recognizing that the Fed is not a private entity but is rather part of the government, and hence, analysis of the implications of the Fed’s balance sheet and income must be consolidated into the government’s balance sheet and income to understand the true impact of the interactions between the Fed and Treasury on the US taxpayer.
Those who argue that Fed remittances are a return of profit to the Treasury on its portfolio are incorrectly viewing the Fed as a private entity that earns income on its portfolio of Treasuries and mortgage securities, deducts its expenses, and returns the so-called “profit” to the Treasury. As will be shown, this is not the proper way to view remittances. The public confusion on this issue is fueled by two faulty and misleading government accounting conventions. The first convention is that the Fed’s security holdings are considered by the Treasury as “securities held by the public” instead of as intra-governmental security holdings. In addition, the National Income and Product Accounts (NIPA) treat Federal Reserve Banks as part of the domestic financial system. This makes it seem as if the Fed is a private firm rather than part of the government. The second convention is that remittances are incorrectly scored as revenue by the Treasury instead of as a net expense. To understand why this treatment of the Fed’s assets and remittances is really an accounting shell game, it is necessary to go a bit deeper into the accounting.
Put simply, the Treasury securities on the Fed’s balance sheet are also a liability of the Treasury, and from the perspective of the government’s consolidated balance sheet, the two exactly offset each other. Now, the Treasury pays interest to the Fed on its Treasury holdings, which is an expense to the Treasury. The Fed uses the interest earned to pay interest on reserves and to cover its operating expenses, and then it returns the unused expense money back to the Treasury. That internal governmental return on the Treasury’s interest expense is not now magically the Fed’s profit. Rather, it is the return of a portion of an expense of the Treasury. It is like you’re giving a dependent child a check for $1000, which is used to cover $50 of school expenses. When the remaining $950 is returned, you, as a family, are not suddenly $950 richer. If the interest expense and remittance transactions were settled on a net basis, there would always be a net transfer of funds to the Fed equaling its operating expenses; that is, in our example, your family has $50 less than before.
It is only a quirk of government accounting that improperly permits the Treasury to treat the return of an unused expense as income for budget purposes. The issue has taken a new turn now that the interest earned on the Fed’s low-yielding Treasuries (which are booked at par and not market) is less than the 4.9% interest costs that the Fed is currently paying on bank reserves. Since the difference is negative, the Fed will be reporting an operating loss. Normally, a loss would result in a reduction in the Fed’s paid-in capital, which presently stands at about $40 billion, and surplus is about $9 billion. But the Fed has precious little capital relative to over $8 trillion of liabilities. In addition, Congress tapped the Fed’s surplus to fund the Highway Transportation Bill, which was capped at $10 billion in 2016. A deal was struck with the Treasury stipulating that, should losses occur that would otherwise reduce the Fed’s capital, the Fed would instead create a negative asset account into which those losses would be booked. There would be no remittances until there is sufficient positive net income to extinguish the negative asset account. So in this case, the Treasury again will be covering the Fed’s losses by pushing them into the future in the hope that the Fed’s finances will turn around. We will see the losses accumulate and can compare them against the Fed’s paid-in capital and surplus to determine whether the Fed is in a negative capital position or not.
Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio
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Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.
