Wednesday, January 13, 2010

The Fed's Profit

. Wednesday, January 13, 2010

Yesterday it was reported that the Fed earned about $46bn last year, mostly because it diversified its portfolio into riskier assets as a way of injecting capital into the banks. Fed payments to the Treasury also increased, and were north of $20bn.

This is unequivocally good news. Combined with the profits from TARP (at least the banking interventions), and it now appears that the government may make as much as $100bn from the interventions into the banking sector. That's right: not only did it not cost us trillions, as some claimed, or even the hundreds of billions of TARP outlay, but there will be a substantial profit.

Last fall, a lot of more liberal commentators like DeLong and Krugman were advocating a Swedish-style nationalization of the banks. As DeLong put it, if the government was sharing downside risk with banks it should share in the upside as well by acquiring equity stakes. Now we see that the government was sharing in the upside by buying depressed assets at low prices, waiting for the markets to stabilize, and then selling them back. All without having to bother full nationalization and the pitfalls that may have entailed.

This is very good news indeed.


Emmanuel said...

Au contraire. This is bad news that's an unsurprising outcome. The Fed bought masses of securities to drive down bond yields. The end result is increased asset prices--it's simple supply and demand. If it really wanted to, the Fed could reap even larger "profits" by distorting markets via even more public intervention.

The basic end result of these actions, however, is subversion of price discovery. As a result, we don't know how this action will pan out when the Fed releases us from this artificiality.

Last I checked, making a profit wasn't a Federal Reserve objective but maintaining price stability and full employment.

Kindred Winecoff said...

I disagree. Yes, the Fed's actions pushed down the yield curve -- although the flight to safety from institutional investors probably played a greater role -- but that is also very good news for a country seeking to finance large amounts of debt. And if the panicked flight from risk overshot, as is likely, then pumping up asset prices closer to their "fundamental" values (whatever those are) is no bad thing.

I also don't buy that the Fed perverted price discovery. Nevermind "distressed" markets, the Fed purchased assets that were essentially unsalable, but were still subject to mark-to-market accounting rules. Since there was no functioning market there was no price, but these assets remained on balance sheets as black holes (despite not being worthless, as we now know and as I always suspected) and firms that were *not* insolvent were threatened with insolvency through illiquidity and accounting rules. By creating a price for these assets, the Fed actually facilitated price discovery; how else could they now unwind at a profit?

So the Fed was able to kill three birds with one stone: 1. restore liquidity to illiquid financial institutions; 2. push down the bond yield making the Porkulus stimulus less onerous; 3. jump-start the market for distressed securities while turning a profit that off-set part of the deficit.

This looks like a win-win-win for me.

So why doesn't the Fed just do this all the time? Because in normal times when distressed assets cannot be purchased for pennies on the dollar, the risk of gambling with public monies is too great. But in crisis times when distressed assets *can* be purchased for pennies on the dollar, the risk of *not* gambling with public monies is great. Esp. when they're pushing against the zero-bound of monetary policy.

The Fed is tasked with maintaining price stability and low unemployment, but as a quasi-private bank it regularly turns a profit (with which it pays off Treasury). Admittedly, this is easier to do when you can print the cash, but it's still far better for the public purse than if they'd shown a loss.

mack said...

This is a great post Dmitry. I just had one of the ‘Doh!’ moments and ran back to correct my own site before publishing my comment. You see my own comment form did not match what I’m about to advise. I get less comments than you, so never noticed any problem. I’ve changed it now anyway so here goes.

money and profit

The Fed's Profit
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