Sunday, February 6, 2011

Bob Murphy asked me to explain the Fed's new accounting rules about remitting earnings to the Treasury. I did an internet search and it appears that the conspiracy theorists see something nefarious. I was doubtful.

The general explanation of the policy is a bit difficult to decipher.
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.
It helps to understand that "surplus" is basically required retained earnings.   Member banks in the Federal Reserve system must purchase stock (at $100 per share) equal in value to 3 percent of their net worths.   A member bank with a net worth, or capital, of $100 million must buy $3 million worth of stock in its Federal Reserve bank.   The Federal Reserve banks must keep a "surplus" or retained earnings equal to the amount of stock that the member banks had to purchase.

The member banks of the Richmond Fed have purchased $5,439 million worth of stock, so the Richmond Fed must keep retained earnings of $5,439 million.

That is simple enough and doesn't really seem to have much to do with hiding losses.

However, if you go to the link where this new policy is described (H4.1) and scroll down to table 10,  you can see that several Federal Reserve banks have negative balances in their amount due to the Treasury.    Under liabilities, the line for Interest on Federal Reserve notes due to the U.S. Treasury is negative for several Federal Reserve Banks.   It is -$31 million for the Richmond Fed.

There is a note at the end of the table:
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.
While this seems a bit odd to me, it amounts to how short the Federal Reserve bank is to meeting the requirement that it have a surplus equal to its capital paid in.  While the Richmond Fed shows that it has the required retained earnings, a surplus of about $5,439 million, it really doesn't.   It only really has $5,408 million.   It is short the $31 million.      Before it can start sending any money to the Treasury, it must make that up by additional retained earnings.

If a Federal Reserve bank took a loss, then this item would be negative.   However, it will turn negative if the Federal Reserve bank didn't have enough earnings to cover the 6 percent required dividend on the stock held by member banks.   And it could turn negative if the Federal Reserve bank failed to  increase its retained earnings enough to match an increase in the amount of stock purchased by member banks.   This would happen if the member banks are increasing their net worth, perhaps due to growth in the overall size of their balance sheets.     

Currently, the total amount due to the Treasury  for all Federal Reserve banks is $613 million, and so the Treasury should expect a substantial weekly payment from the Fed.    If that total number starts turning negative, then it is time to question the payment of dividends to the member banks.    If it becomes progressively more negative, losses will start to look like the problem.   And if it starts to approach the surplus and paid in capital of the Federal Reserve banks, the insolvency of the Federal Reserve approaches.

However, describing Federal Reserve insolvency as being how much the Federal Reserve banks must retain before they can resume payments to the U.S. Treasury would be a bit of a euphemism, to say the least.

1 comment:

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