"Creative Accounting" Makes Fed Insolvency Impossible

Tyler Durden's picture

To all who thought that the FASB gives leeway only to banks when fudging their numbers, and boosting their equity capital in ways previously unheard of, we have a surprise. The latest entrant in the "accounting gimmickry" club is none other than the Fed. And since the Fed is not auditable by anyone, it gives itself permission to change and bend the rules in any way it desires. Following on recent speculation that the Fed could in theory have a equity capital deficiency due to its massive asset book, and its tiny equity buffer, both discussed many times previously on Zero Hedge (here and here), the Fed recently announced as part of its January 6 H.4.1 release "an important accounting policy change with the release of its weekly H.4.1 report on January 6 that effectively  prevents it from facing a negative capital position even in the event that it incurs substantial losses." Here is how Bank of America's Priya Misra explains this curious, and most certainly politically-motivated development: "The Fed remits most of its net earnings on a weekly basis. Prior to this accounting change, any unremitted earnings due to the Treasury would accrue in the "Other capital" account, but will now be shown in a separate liability line item called "Interest on Federal Reserve notes due to the Treasury.” As a  result, any future losses the Fed may incur will now show up as a negative liability (negative interest due to Treasury) as opposed to a reduction in Fed capital, thereby making a negative capital situation technically impossible regardless of the size of the Fed’s balance sheet or how the FOMC chooses to tighten policy." And there you have it: instead of reducing the left side of the balance sheet upon the incurrence of losses, the Fed has decided to fudge the right side. And presto. No more possibility of insolvency ever again. Which only means that the Fed's now ridiculous DV01 of just under $2 billion will in no way prevent the world's biggest hedge fund from taking proactive steps to actually mitigate rate risk, and in fact will likely encourage it to gamble even more with taxpayer capital.

More from Bank of America:

Accounting change prevents a Fed “insolvency” scenario

Mounting concerns about Fed “insolvency” post QE2

The Fed announced an important accounting policy change with the release of its weekly H.4.1 report on January 6 that effectively prevents it from facing a negative capital position even in the event that it incurs substantial losses. The timing of the change is not coincidental, as politicians and market participants alike have expressed concerns since the announcement of QE2 about the possibility of Fed “insolvency” in a scenario where interest rates rise significantly. These concerns have prompted some observers to suggest that the Fed may be unable to tighten policy sufficiently once the economy recovers, since doing so could result in a negative capital situation and the need for a Treasury “recapitalization,” thereby compromising the Fed’s political independence.

Fed required to remit profits to Treasury (not build capital)

Since 1947, the Board of Governors has required that the Reserve Banks remit nearly all net earnings to Treasury. Remittances are roughly equal to income from loans and securities holdings less operating expenses, interest paid on depository institutions’ reserve balances, dividends paid to member banks, and any amount necessary to top up the Fed’s capital. Fed remittances have surged  since late 2008, reflecting its aggressive balance sheet expansion in the context of nearzero term interest rates (Chart 1). The Fed could potentially incur losses, however, if short term rates rose such that the interest paid on bank reserves exceeded the interest income of the System Open Market Account, or SOMA portfolio. Similarly, the Fed could face capital losses if it were to sell securities below their original purchase price (Chart 2). Note that the SOMA portfolio is not marked to market, but is reported on a par-value basis each week, so higher yields would only impact Fed earnings in the context of asset sales.

Accounting change prevents negative Fed capital situation

The Fed remits most of its net earnings on a weekly basis. Prior to this accounting change, any unremitted earnings due to the Treasury would accrue in the "Other capital" account, but will now be shown in a separate liability line item called "Interest on Federal Reserve notes due to the Treasury.” As a result, any future losses the Fed may incur will now show up as a negative liability  (negative interest due to Treasury) as opposed to a reduction in Fed capital, thereby making a negative capital situation technically impossible regardless of the size of the Fed’s balance sheet or how the FOMC chooses to tighten policy. There will be no change to the current practice of remitting profits to the Treasury on a weekly basis, but the Fed will postpone any remittances if this line item becomes negative. In effect, any losses will be offset against future Fed remittances to the Treasury. In our view, this policy appears  to be a clever solution to the Fed’s inability to provision for potential future losses by retaining earnings today. We expect it to mitigate – though not fully allay – concerns about Fed solvency.

And the full notification in the January 6 H.4.1 release:

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.

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nontaxpayer's picture

Sure, they can fudge and cook the books and the sheeple will stay uninformed what is going on...but fundos will still apply.

Sudden Debt's picture

fundos... :)

 

Goldman just announced a golden ticket to make money by shorting BAC:

 

Goldman Suggests Buying Calls on Bank of America (BAC)

http://www.benzinga.com/analyst-ratings/analyst-color/11/01/794181/goldman-suggests-buying-calls-on-bank-of-america-bac

 

 

Sometimes, I just want to create a account on the yahoo message board and give these guys a clue...

But that would just ruin the fun :)

http://messages.finance.yahoo.com/Stocks_%28A_to_Z%29/Stocks_B/threadview?m=tm&bn=1903&tid=1632970&mid=1632970&tof=1&frt=2

SheepDog-One's picture

If anyone ever wonders how its possible to pull off this scam day after day, read the Yahoo!Finance message boards and it all becomes totaly clear.

Divided States of America's picture

Fed adopting something like the Repo105's like what LEH did?

Turd Ferguson's picture


Last year, I gave you $1350 by Halloween.

Today, I give you $1600 by Memorial Day.

http://tfmetalsreport.blogspot.com/2011/01/darkest-before-dawn.html

Whatta's picture

As long as one Ameican is left working (is there still one?), there is hope for repayment.

I still find it way cool that the FED can create play money out of thin air, and then (hopefully) be repaid with actual earned income tax dollars. Whatta racket to own.

attst487's picture

When do we begin repaying ourselves with would-be tax dollars?

Whatta's picture

shhhhhh. The rest of the world is not supposed to know we have no real GDP any longer. Just a nation of fiat swappers in financial matters.

I spent a few fiats in the past week on some items for the farm...

...new trailer tires - made in Thailand, new metal cut-off disks - made in freakin' Russia, new work shirts - made in Cambodia, new welding mask - made in China. Oh, and my new HP computer was shipped from its assembly point in Mexico.

I think I see the problem.

AGoldhamster's picture

This is still true - or even more true or confirmed as of NOW:
http://marketcyclesresearch.blogspot.com/2011/01/imho-we-are-very-close-to-next-sell-off.html

and as usually the early birds, rats are in london ... while the bagholders aka the sheep keep staring at the DOW ... look at FTSE!

And btw would be pretty surprised not to see Gold 133x or silver 27.x or even 26.x - so that Blythe can cover more shorts and shake more trees and get some more physical from the sheep ... btw with sacrificing indexes and munis and profiting nicely from fear again ... duration change: sell off might last into mid of February or so ... btw Harry giving back some? Not?

And have a closer look at brent ... could be rolling over too - eventually.

Guess HUI will see 49x pretty soon ... with 493 being a possible target.

Sudden Debt's picture

maybe not insolvent but what when the dollar is worthless?

 

I'LL BUY THE FED FOR 1 OUNCE OF GOLD OR 1 QUAZAR TRILLION DOLLARS !!

LongSoupLine's picture

where the fuc is Ron Paul?!  Get his ass a chainsaw!

Hedgetard55's picture

"Negative interest owed to Treasury" means losses owed to FED by Joe Taxpayer. Thank you Hanky Panky Bernanke!

hedgeless_horseman's picture

...in fact will likely encourage it to gamble even more with taxpayer capital.

Not exactly accurate, but I get the point.  Taxpayer liabilities might be more accurate, but I am not a CPA, PhD, or CFA.

In actuality, the Fed has very little of my capital, and I hope to keep it that way.

101 years and counting's picture

"any future losses the Fed may incur will now show up as a negative liability (negative interest due to Treasury)"

Translation:  The Fed will pass the losses onto the treasury and let the taxpayers pay for their losses. 

SheepDog-One's picture

Simply changing a technical definition of a word now means all is well? Give me a break, at some point soon reality steps in and trumps all.

Cdad's picture

Dog,

This story is completely logical, and it fits in nicely with all of the fictional earnings reports coming out of criminal syndicate Wall Street banks right now.  I can hardly wait for Blight on America bank's earning report.  Should be sweet fiction reading.

This is what plutocrats do.  Laws and rules are for Average Joe.  Anything to keep the ponzi scheme going.  So put me all in on red!  No, black!  Investing is easy, man.

SheepDog-One's picture

The only thing I keep wondering about is when they have planned for it not to go on any longer, tightrope walking across the grand canyon is a risky job! 

And like when Rusty was talking to his dad at the hotel after being caught skinny dipping in the pool with Christy Brinkley, 'You believe me dont ya son'? 'Sure dad...but do you think mom will buy it'? 'Good talk Rusty'

So...anyone think the Chinese are buyin it? I dont.

Cdad's picture

Dog,

That is what is so sweet about this currently crappy situation.  The only people buying this BS are the criminal syndicate Wall Street bankers themselves!  They are the bag holders [of their own fiction, no less]. 

Average Joe continues to sell the crap out of stocks...no matter the news.  In a maddening and tortured sort of way [that is taking far too long because of super trading computers], the market is disciplining them.  It is my belief that the tightrope you refer to is shaking already...and criminal syndicate Wall Street bankers are about to start receiving their pink slips soon...falling into the canyon.

Even more sweet, propagandists at the Blow Horn [CNBC] will start receiving their pink slips soon, as well.  

It has been a long and tough slog, brother, but the market is working despite all the forces that are trying to rig the market.  You just wait and watch. 

Get your Whack-a-Mole game together, Dog.

attst487's picture

"Always bet on black." -Wesley Snipes, Passenger 57

Cognitive Dissonance's picture

This rule change is just another example of manufacturing reality. Don't like the reality you're seeing? Just change the rules. There, all better.

The reason the insanity can continue longer than anyone can believe is because we are viewing the insanity with a static set of rules. Silly rabbit, insanity and insane institutions can change the rules at any time. 

SheepDog-One's picture

Yep CD but theres no spinning a world famine, and gas to $4 then $5 and higher. The FED can claim anything it wants but the country is shut down just the same.

DaveyJones's picture

we don't call it famine, we call it fashionably thin

SheepDog-One's picture

When do the fashionably thin start shooting?

DaveyJones's picture

we don't call it shooting, we call it a point of order

Cognitive Dissonance's picture

Agreed. I didn't say the insanity wouldn't end, only that it has and will continue longer than most could believe possible.

jus_lite_reading's picture

Correction- is has continued longer than even the best Enron account could have imagined...

Kalifornia here we come!

hbjork1's picture

Discussion of the "change in government" in Sudan on the NPR DR show this morning. 

20% of the people live on less than $2/day.   Out of work numbers, 50% to 70% depending upon age group.  What did ZH say about the dear departed?  How many tons of gold?   

Recently, it seems we have an unusually large number of congresspeople saying that they do not plan to run again. 

The next round of elections could be verrrrry interesting. 

6 String's picture

ZH needs a new acronym. I vote for:

TWCTR or TWCTFR

Translated: "They will change the rules" or "They will change the fucking rules."

....Because we've officially seen enough evidence of this to know the fascist elites will.

*Remember the overnight you can't short financials rule during the financial collapse?

*Remember the change the accounting rules for total legerdemain?

Every market is totally rigged. My prediciton, within four short years--and probably much sooner--when the silver paper contracts default on the COMEX, our governement will simply change the fucking rules. They will in followig order:

*Set a fixed price for silver redemption (one that is highly unfavorable for the speculative "hoarders").

*For those that don't turn in their silver at the said fixed price, a VAT (Value Added Tax) will be assigned on any further transactions beyond the fixed price to the tune of an 80% capital gains tax rate.

And they will do this, of course, for the good of the country because the evil hoarders ruined the real market: the physical, for industrial use.

The will do this-TWCTFR--because they can. There is no safe haven except far off grid, sustainable living, in a fully protected compound.  

 

DaveyJones's picture

creative accounting makes as many things possible as impossible

I think I need to buy a gun's picture

How can they be insolvent when they can revalue their gold to whatever price they want?

Gold capitulation day....China's Hu " The dollar system is a thing of the past"

Everything finally rolled over. Can anyone say new monetary system or gold revaluation?

stoneman sacked's picture

As one accountant famously said "Profit is just an opinion"

Rider's picture

Freaking unbeliebabled no one cares about the accounting crimes.

The corruption is so rooted you think is part of the same tree.

plocequ1's picture

Well, There it is. Rally on. Time for me to move north where the Moose and Antelope play

SheepDog-One's picture

Yea yea...change the terms, pull the wool over the american sheeples eyes and all....but the real question is- 'Ya think the Chinese are buyin it'??

London Banker's picture

The Fed remits 85 percent of interest received on US Treasuries back to the Treasury under a long standing arrangement (1960s or so).  The amounts weren't significant until monetization of the debt under QE2.  Now that the Fed is holding trillions in Treasuries, the amounts of interest are enough to warrant breaking them out as a specific liability.  This accounting change seems to make sense to me.  As interest rates rise, and QE3 looms, the amounts could become quite large.  It's worth having a separate entry to make the flows clear.

QQQBall's picture

Flows clearer? Not a CPA, but it seems you could reduce interest payments due to the Treasury by the amount of "negative interest". This would effectively have the Treasury eat the losses on the Fed's books?

unununium's picture

Precisely.  It will be a long time before the Fed ever remits anything to Treasury again.  Like never.

But this accounting change did not create that problem.  It just changed the name of the capital shortfall account.

Greenhead's picture

So they shoveled out tons of good paper to buy/exchange trash at par and now the trash gets written down and accounted for in the money due the Treasury account.  How else would the taxpayers eat the loss?? 

QQQBall's picture

Flows clearer? Not a CPA, but it seems you could reduce interest payments due to the Treasury by the amount of "negative interest". This would effectively have the Treasury eat the losses on the Fed's books?

youngman's picture

What this shows is that in some boardroom..and with some committiee...they are discussing the end game..the failure..and how they can hide it....

hedgeless_horseman's picture

Raising rates?  Sure.

End game?  Not so sure. 

The Fed's and the .gov's ability to scare the pants off 99% of America on a whim enables them to do whatever the fuck they want, and they know it.  We stepped down the slippery slope of Fascism long ago, and they are far better at it than the old school.  Act accordingly.

TruthInSunshine's picture

Ya' know, that reminds me of the times when the market was down 5% to 10% in one day, way back when in 2008, when Congress initially voted down a blank check for Paulson & TARP...

...ahhh....good times. And totally NOT manipulated events, either.

JW n FL's picture

please stick to the official story...

jus_lite_reading's picture

Actually, I said it first- this a PONZI so well concieved, so buttoned down, the Fed can never be technically "insolvent," thanks to creative Enron style accounting. That being said, your money is worth only as much as OTHER nations think it to be- big guns keep the US safe. But what keeps the EU safe? Answer- nothing.

Alas, the EU is already imploding before your very eyes...

Cursive's picture

So the FRB, a private consotium of 12 member banks, is ultimately backstopped by - wait for it - US taxpayers.

hedgeless_horseman's picture

Welcome to the party.  You will want a drink.

Cursive's picture

@HH

I've had a front row seat at the party for quite a while. My above comment was meant merely to concisely explain the real reason behind the "accounting change."