We know its not Paulson, Ackman, or SAC; is it Dalio's Bridgewater? No, the world's most profitable private entity that is in business to generate profits via speculation in financial markets is, drum roll please, the Federal Reserve. Stone & McCarthy (SMRA) estimates the Fed will make around $90bn profits in 2012. Of this around $87.5bn will be remitted to the US Treasury - a new record high (quite helpful when one is trying to avoid a debt ceiling using 'extraordinary measures' though we assume this is already penciled in due to its consistency). Since 1947 the Federal Reserve has paid the Treasury roundly $975 bln, about 1/3 of which has been paid over the past 6 years. In other words, the cumulative Federal deficit since 1947 has been reduced by nearly $1 trillion since 1947 due to the repatriation of Fed earnings to the Treasury Department. SMRA estimates that this profitability, thanks to the spread between SOMA coupon income and IOER will likely lift the Fed's profitability to around $120bn in 2013, but a 1% rise in yields would translate into a $275bn loss.
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As SMRA notes:
The Fed doesn't have to mark securities in SOMA to market. Only if securities are sold are the profits or losses booked.
Moreover, even with the onset of the ultimate exit, the Fed won't start selling securities until some time later. But as we approach the onset of the exit and later the onset of Fed asset sales, the likelihood is that yields on these securities will be higher than at the time these securities were purchased. This implies capital losses on securities to be sold, and this would negatively impact on Fed earnings...
Ultimately, the Fed will be faced with booking losses on asset sales, while also suffering from declining net interest income as the interest rate on reserves is increased to effect a higher Fed funds target.
The bottomline is that there will come a time when the Fed may not be profitable. But this has to be viewed in the context of the Fed's repatriation of what will be several hundreds of billions of dollars in the years immediately ahead, and the nearly $1 trillion paid between 1947 and 2012.
The Fed can account for losses without eroding its capital, simply by suspending payments to the Treasury until such time as the Fed returns to profitability.
Source: Stone & McCarthy