January 14th, 2010 10:28 AM by Lehel S.
Reporting from Washington - The Federal Reserve reported a side benefit to its massive intervention into the financial system -- a record profit of $46.1 billion last year on the central bank's investments.But experts said that gain, which will be paid to the U.S. Treasury, could be offset by losses in the future when the central bank starts selling the Treasury bonds and other assets it has purchased in unprecedented amounts to try to stabilize the economy.For that reason, the Fed did not make a big deal out of the news Tuesday, announcing it in a short news release, said Vincent R. Reinhart, former director of the Fed's Division of Monetary Affairs."Any other entity that had record profits would have hired a band or had a parade," said Reinhart, a resident scholar at the American Enterprise Institute, a Washington think tank. "Why would the Fed downplay that? They don't want you to focus on the current profits because when it comes to tightening policy they'll probably get losses on that same portfolio."Federal Reserve officials said Tuesday that they believed all the investments they made were safe, including loans to help facilitate the sale of investment bank Bear Stearns and rescue insurer American International Group Inc. But that does not preclude some losses.The Fed's balance sheet, the value of all of its holdings, has more than doubled to $2.2 trillion as it has tried to keep the financial system afloat since the financial crisis began in 2008. Its huge investments in securities led to much of its increased profit, said Christopher S. Rupkey, chief financial economist for Bank of Tokyo-Mitsubishi."It's the interest on over a trillion dollars of securities," he said of the Fed's profit. "They have an enormous balance sheet, and those assets are contributing more to their earnings, putting more money in the kitty for the Treasury and helping to lower the budget deficit."But he noted the profit was relatively small given the size of the balance sheet and the $1.4-trillion federal budget deficit for the fiscal year that ended Sept. 30. "It may be a drop in the bucket . . . but every little bit helps," Rupkey said.The Fed's profit last year was $14.4 billion more than what it paid into the Treasury for 2008 and more than it has ever earned since it began operations in 1914. The previous record was $34.6 billion in 2007.But Federal Reserve officials stressed that the goal of the central bank is stabilizing monetary policy, not earning profit. The Fed is funded by its earnings, and profit is turned over to the federal government."The significant increase in earnings on securities was primarily due to increased securities holdings as a result of the Federal Reserve's response to the severe economic downturn," the central bank said. As of Dec. 30, the Fed held $1.85 trillion in Treasury bonds and other securities, up from $496 billion at the end of 2008.As the Fed stepped up its efforts to prop up the faltering financial system, it bought large amounts of securities from the U.S. Treasury and other entities, including mortgage-backed securities held by government-sponsored home loan financing companies Fannie Mae and Freddie Mac, which were taken over by the federal government during the crisis.Those purchases have helped push down mortgage rates. Mortgage-backed securities pay a higher rate than Treasury securities, helping account for the increased profit."They lend at a higher rate than they borrow. The rate they borrow at is approximately zero" percent, Reinhart said. "Central banking is a really good business, and if you have a big balance sheet you can make a lot."As part of the $46.1-billion profit, the Fed earned $2.6 billion on currency swap arrangements with central banks in 14 countries and other investments in foreign currency. The Fed also earned $700 million from fees for services it provided to banks.But the Fed's profit probably will decline in the future, Reinhart said, although the central bank is unlikely to post annual losses."The Federal Reserve is not the new Goldman Sachs. They're not a profit center for the government," he said. "Their profits are small in the scheme of things, and they should be properly viewed as offset by potential future losses."