Friday, January 21, 2011

HOT: Fed Hides Major Accounting Change

Reuters has a very hot story out tonight on an accounting change the Fed snuck into a regular weekly report. It will move off the capital part of its balance sheet any losses the Fed may have on paper it purchased from Goldman Sachs, or anybody else for that matter. Here's Reuters via CNBC (My emphasis):
Concerns that the Federal Reserve could suffer losses on its massive bond holdings may have driven the central bank to adopt a little-noticed accounting change with huge implications: it makes insolvency much less likely.

The significant shift was tucked quietly into the Fed's weekly report on its balance sheet and phrased in such technical terms that it was not even reported by financial media when originally announced on Jan. 6.

But the new rules have slowly begun to catch the attention of market analysts. Many are at once surprised that the Fed can set its own guidelines, and also relieved that the remote but dangerous possibility that the world's most powerful central bank might need to ask the U.S. Treasury or its member banks for money is now more likely to be averted.
But they are averting asking the Treasury for money in the future by an accounting gimmick that will simply dump the debt off the capital part of the balance sheet, so it won't be reported as a loss, and make it a liability to the Treasury. More from Reuters:
[According to]Raymond Stone, managing director at Stone & McCarthy in Princeton, New Jersey, "An accounting methodology change at the central bank will allow the Fed to incur losses, even substantial losses, without eroding its capital."

The change essentially allows the Fed to denote losses by the various regional reserve banks that make up the Fed system as a liability to the Treasury rather than a hit to its capital. It would then simply direct future profits from Fed operations toward that liability...

 "Any future losses the Fed may incur will now show up as a negative liability as opposed to a reduction in Fed capital, thereby making a negative capital situation technically impossible," said Brian Smedley, a rates strategist at Bank of America-Merrill Lynch and a former New York Fed staffer.

"The timing of the change is not coincidental, as politicians and market participants alike have expressed concerns since the announcement (of a second round of asset buys) about the possibility of Fed 'insolvency' in a scenario where interest rates rise significantly," Smedley and his colleague Priya Misra wrote in a research note.
Bottom line: We all knew the Fed was going to have to do some kind of monkey business to deal with all the junk securities it purchased, here it is: Negative liabilities. Yes, only at your local Fed.


  1. Be careful, or CEO's will start clamoring for this to be incorporated into GAAP accounting. Hell not only would it boost EPS for all S&P 500 companies, but it would also add leverage and crank up the ROE too. Can you imagine where the stock market will go once the Wall Street robo-traders plug these new rules into their Excel models? The robo-traders will go INSAAAANE! DOW 36,000 will be conservative.

  2. How will the Fed's negative liabilities due from Treasury show up on Uncle Sam's balance sheet? Ooops, Uncle Sam doesn't have one. America has abysmal leadership.

  3. OK...listen, anytime you get a hot story from Reuters...its going to be propaganda. Do you realize that all news outlets get their news from Associated Press and Reuters...almost exclusively? Did you know Reuters owns AP?

    So, now you must ask yourself the question as to why Reuters would release this "hot" information? What are there motives.

    I never ever trust Reuters or Associated Press. Don't even get me started about the ownership of these companies.

    When will people wake up to the BS being fed to them. I beginning to think Americans enjoy shit sandwiches 24/7.

  4. Now we can only hope that democrats and repubs see the merits of the call by Ron Paul for a comprehensive audit of the Fed as the bankers' banker and the major tool of the financial oligarchy.

    " For the government to permit banks to issue money, borrow that money, and pay interest on it is idiotic! " Bill Hixson.

    The very real financial relationship between the Fed and Treasury, just one of the outcomes of the Fed-Treasury Accord, is a facade that allows acceptance of the government borrowing and paying interest to private bankers, simply by virtue of the Fed's annual shoveling of its excess earnings back onto the Treasury's sort-of balance sheet.

    While that relationship actually costs the taxpayers of this country hundreds of billions of dollars every year, the high profile transfer of $30 to $50 billion in excess earnings from the Fed to Treasury makes it all seem so reasonable.

    Now the Fed's net income is capable of becoming a negative number - and the mechanism by which that negative number becomes additional taxpayer burdens goes further behind the curtain.

    Audit the Fed.
    Abolish private money creation.
    Support Kucinich's NEED Act of 2010 and restore Constitutional money.

  5. Lol, and we are going to give them more power to supervise and regulate the financial system in order to prevent fraud?

  6. Good post. Can you explain to me how the Fed, a quasi-private corporation, taps the US Treasury? My understanding is, the Fed is capitalized by its owners, not by Uncle Sam (made possible by the fact that at the time of its founding, the Fed's owners had more money than the federal gov't). It it my understanding that the Fed earns a 6 percent dividend on its right of seigniorage, and pays profits in excess of its dividend requirement to Treasury. Please clarify.

  7. Democracy has created a society of retarded bratty parasites as it always does. There are 6B people in the world and greater than 5B are parasites (liberals, socialists, collectivists, Oblermann, Maddow, Pelosi-type animals, muggers). Democracy will murder us ALL over time.

  8. Um, doesn't Congress have to authorize adding debt to our balance sheet? Doesn't this shatter the notion that the Fed is an arms-length non-government entity? If we are going absorb their debt, do we get to audit it?

    It is actually sort of humorous, the Fed is using the Treasury like they are Enron and we are a Cayman shell company.

    In the end, it merely records the transaction the way it was always going to work out: with the toxic debt moved to the taxpayer's books.

  9. Anonymous,

    Do they own CNBC too?

    Anonymous 2

  10. They own EVERYTHING!

    THe FaMiLY iS 100% SaFe

  11. The fed is money, they can take or give,they have no rules.this is a war with china.we made a monster.

  12. Am I missing something here? Because it sounds to me like we are now being instructed in the formal method by which the Fed will transfer losses from it's books to the taxpayers of the United States.

    Like that ~ $2 Trillion in mortgage backed securities that the Fed took as collateral for "loans" to Wall Street. They're worth what now, maybe 50 of their face value, tops?

    Since policy is really only about giving the the banking/govt oligarchy a little extended playing time, unemployment and foreclosures are going one way - up.

    Which means the value of the mortgages go down.

    But that's not a problem now, because Bernanke will just sneak up to the Treasury one night and stuff the bill for the losses under the door.

    At that point it will belong to the taxpayers of the United States. Not long after we'll be told that taxes have to go up a lot, immediately, or the credit rating of the United States will be downgraded.

    So you and I, and our grandchildren, will enjoy the privilege of laboring as slaves for the leisure of the banking and government class, until we die.

  13. I feel sorry for the 20-30 year olds..They are going to live in slavery not unlike the 1850s black man in Georgia. People who actually work for a living are just plain stupid.

  14. Check out the actual release.

    It's hidden in these inscrutable paragraphs:

    The Board's H.4.1 statistical release, "Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks," has been modified to reflect an accounting policy change that will result in a more transparent presentation of each Federal Reserve Bank's capital accounts and distribution of residual earnings to the U.S. Treasury. Although the accounting policy change does not affect the amount of residual earnings that the Federal Reserve Banks distribute to the U.S. Treasury, it may affect the timing of the distributions. consistent with long-standing policy of the Board of Governors, the residual earnings of each Federal Reserve Bank, after providing for the costs of operations, payment of dividends, and the amount necessary to equate surplus with capital paid-in, are distributed weekly to the U.S. Treasury. The distribution of residual earnings to the U.S. Treasury is made in accordance with the Board of Governor's authority to levy an interest charge on the Federal Reserve Banks based on the amount of each Federal Reserve Bank's outstanding Federal Reserve notes.

    Effective January 1, 2011, as a result of the accounting policy change, on a daily basis each Federal Reserve Bank will adjust the balance in its surplus account to equate surplus with capital paid-in and, in addition, will adjust its liability for the distribution of residual earnings to the U.S. Treasury. Previously these adjustments were made only at year-end. Adjusting the surplus account balance and the liability for the distribution of residual earnings to the U.S. Treasury is consistent with the existing requirement for daily accrual of many other items that appear in the Board's H.4.1 statistical release. The liability for the distribution of residual earnings to the U.S. Treasury will be reported as "Interest on Federal Reserve notes due to U.S. Treasury" on table 10. Previously, the amount necessary to equate surplus with capital paid-in and the amount of the liability for the distribution of residual earnings to the U.S. Treasury were included in "Other capital accounts" in table 9 and in "Other capital" in table 10.

    And you can see it in action in the Fed Res member bank information list. Note some of the negative numbers.

    Interest on Federal Reserve notes due to U.S. Treasury (15) 613 7 379 -36 -4 -31 69 65 22 -1 13 51 80

    with note 15:
    15. Represents the estimated weekly remittances to U.S Treasury as interest on Federal Reserve notes or, in those cases where the Reserve Bank's net earnings are not sufficient to equate surplus to capital paid-in, the deferred asset for interest on Federal Reserve notes. The amount of any deferred asset, which is presented as a negative amount in this line, represents the amount of the Federal Reserve Bank's earnings that must be retained before remittances to the U.S. Treasury resume. The amounts on this line are calculated in accordance with Board of Governors policy, which requires the Federal Reserve Banks to remit residual earnings to the U.S. Treasury as interest on Federal Reserve notes after providing for the costs of operations, payment of dividends, and the amount necessary to equate surplus with capital paid-in.

  15. " It will move off the capital part of its balance sheet any losses the Fed may have on paper it purchased from Goldman Sachs, or anybody else for that matter. " Those investments are still on the balance sheet.

  16. @TanGeng: Thanks for posting the text. You can clearly see from it that Mr Wenzel completely misconstrued the press release, which says simply that the Fed is changing its accounting
    and the change may alter the timing of its payments to the Treasury. That's all it says, folks!

    The Fed pays itself a 6 percent dividend for mismanaging the nation's money supply. "Residual earnings" is what it takes in over and above that 6%; residual earnings are the surplus which the Fed forks over to the Treasury. Yep, US taxpayers profit from Fed operations. Now, however, the cost of holding an enormous portfolio of cut-price mortgages has eliminated any Fed surplus, so they are changing the accounting to reflect this. While any accounting change should be viewed with suspicion, this one by the Fed certainly has nothing to do with shifting its financial liabilities onto the Treasury. There's no provision for that in the Federal Reserve Act. That's why the Congress had to pass the bank bailout: to put taxpayers on the hook for the TARP costs. Any attempt by the Fed to bail them out by itself would have fatally undermined the dollar because of all the money printing that would have been necessary.

  17. @Anonymous 1-23 8:29

    I said it will move losses off the capital part of the balance sheet , which it does. The old accounting method would have resulted in a reduction in the Fed;s capital (or that of its branches0

  18. @anonymous 1-23 8:44

    You are wrong from the word go.

    First TanGen's post actually supports the article and references the actual new accounting.

    Second there was no press release, it was hidden in a foonote of a weekly release.

    Third, if you don't think the altering of the timing of payments is significant, then loan me !00 at 10% for a week and then I'll announce that I will instead pay it back in 30 years.

    Fourth, you sue me in a car accident and win a million dollar claim which I then cstate I don;t have to pay you until after I pay the $10 on the $100 I owe.

    Oh yeah no problems with any of this.

  19. This sort of accounting practice is unknown in the business world. In essence, the Fed is claiming it can re-capitalize at any moment by any amount by counting the amount as money overpaid to the treasury. The overpayment will be deducted out of assumed future earnings.

    Imagine a company with 10 million dollars in initial equity, borrowing 20 million dollars from a bank, losing all 20 million, and then claiming the company still has 10 million dollars in equity because the company has "overpaid" its shareholders 20 million dollars in dividends.

    That said, the recapitalization works in the opposite direction, too, in that any improvement in capitalization will be immediately remitted the US treasury.

  20. Thanks for the favor of your responses, gentlemen.

    Mr Wenzel, if there's no surplus to rebate to Treasury, then the timing of those payments is irrelevant. The Fed only "owes" the Treasury surplus earnings. ... And, fwiw, a "weekly release" is a press release.

    Mr. TagGeng: you seem to understand this better than Mr Wenzel. Yes, the Fed accounts differently, as it can and must: No private business can print "money", and no private business has a fiduciary obligation to promote economic growth. I am afraid your analogy to a hypothetical private company is therefore not germane.

    Thanks for pointing out that if future Fed surpluses, if any, will immediately be remitted to Treasury.

  21. @Anonymous 1-23 8:29

    You write:

    "...the timing of those payments is irrelevant."

    This is precisely my point. It's a bogus entry to hide the fact that the losses should be written down against capital. The timing of the payments are irrelevant! Because it is quite possible they will never be made. It's bogus accounting.

    And your Federal Reserve apoligizing via this doozy is over the top:

    " Yes, the Fed accounts differently, as it can and must: No private business can print "money", and no private business has a fiduciary obligation to promote economic growth"

    Since when does Fed money printing justify bogus accounting methods?

  22. Sir, we agree. "Timing" is not the issue; it's irrelevant. The issue, apparently, is whether the Fed is a business or a quango. I think it's the latter. Or is the problem really rooted in ideology?

    Accounting methodology is not set in stone. Mr Wenzel, as a economically sophisticated person you know that accounting conforms to business needs, not the other way around. Every industry modifies its accounting methods to reflect the unique and changing circumstances of its business. The Fed, of course, is not a business. Should it account for its operations like Ford or IBM?

    Aside: What does "cash flow negative" really mean for an entity that can print cash flow?

  23. WOW! 6% I went to my local bank and the CD there was much much less than 6%. I would cut off my strawberry picken hand to get guaranteed 6% rates! Is this fo real? I have been thinking about opening a chinese bank account with the new chinese banks coming to the USA and having my deposits denominated in YUAN, does the china banking system pay thier fed equivalent 6% to mismanage the money supply?

  24. Yeah, six percent sounds pretty good right now. Wasn't so hot in the '70s though. I suppose the fixed dividend gives the Fed an incentive to fight inflation.

    I think of the Fed as the first privatized government function -- early Reaganomics. It came out of a deal struck by the Progressives with the NY bankers, and it benefited both parties. The Progressives freed the economy from the tyranny of the gold standard -- which benefits the rich who own all the gold at the expense of everybody else -- and the bankers gained control over the stability of the banking system. In theory, who would you rather have control the money supply: bankers or politicians? At least bankers have some skin in the game.

    As Shakespeare wrote, the root of our present problems lie not in the stars but in ourselves. Our institutions are workable; some of the people running them are another matter.

  25. I would like to add that I applaud the moderator of this site for allowing open debate of his post. Many do not.

  26. The way I see it negative cash flow and negative capital places a limit on the ability to conduct monetary policy - specifically sterilization of existing excess reserves or tightening of the money supply. The size of the negative cash flow and negative capital would determine to what extreme.

    As of this moment, the Fed is basically doing what the commercial banks did in the 2002-2007 period, paying short term interest rates for long term return. The fed is paying IOER on excess reserves and using that to buy treasuries. It's remitting record revenue to the treasury because of that position. Is this a good bet?
    If the commercial banks start withdrawing ER at present rate and loaning it out, the Federal Reserve may be forced to raise IOER to sterilize money. When IOER rises in conjunction with long term yields, the Federal Reserve may lose a lot of capital and go cash flow negative. Negative capital means that it is very difficult to shrink the money supply. The Fed would not be able to sell its securities to recall all outstanding dollars and excess reserves.
    Cash flow negative means that the Federal Reserve would be easing the money supply by default. It would be leaking out more cash into the economy than it takes in from the market. Again, both of these situations would limit the ability to conduct sound monetary policy, namely normalizing monetary policy.

    The accounting trick is very amusing though. First, we have to assume that the Fed is cash flow positive over the long run. Second, the Treasury is sort of on the hook but making no guarantee of Fed capital shortfall directly. The treasury is actually spared the headache of immediately capitalizing the Fed in such a situation. In a way this is better for the treasury. But everyone else should be looking at them funny.

    Just imagine going to a bank for a loan with no liquidity but claiming that you had 20 million in capital because shareholders had been overpaid 20 million in dividends. No banker would accept that as capital or collateral. The banker would give you a funny look and boot you right out. The Fed doesn't play by our rules though.

  27. Just a wild idea - what if everyone quit their jobs, bought a gun and learned how to grow their own food?

  28. Cut to the chase: quit your job, buy a gun and blow your brains out. It's quicker and less painful than starving to death.

  29. @Anonymous pest January 24, 2011 5:59 PM

    "In theory, who would you rather have control the money supply: bankers or politicians? At least bankers have some skin in the game."

    I'd rather have a private cartel with a monopoly of creating counterfeit money and directing purchasing power towards itself.

    It is certainly more fair than having a group of rich evil people who have amassed all the gold in the world and have an effective monopoly on all the purchasing power in the world.

    Do you see the flaw in my reasoning? (Actually, the second part is taken from your comment, so some of the flaws are borrowed from you)

  30. It is a helpful article for its readers. Thanks for posting.