Time To Buy CDS On The Boston Fed?

Something interesting happened in last week's H.4.1 release: the Fed disclosed that, for the first time ever, a Fed bank actually suffered a "loss" when the Boston Fed's Interest on Federal Reserve Notes (IOFRN) liability went negative, and quite negative at that.

As a reminder, the IOFRN liability is the accrual of Federal Reserve income to be repatriated to the Treasury the following week, or money made by the Fed system stand alone "hedge funds."

So does this whopping miss indicate an actual loss by a Fed - something that every economist says is inconceivable (after all they can just print it away). Maybe. Maybe not. Here is Stone McCarthy with an alterantive explanation, which shows that the only thing more screwed up with the modern financial system, is the accounting practices that govern it.

This accounting abnormality stemmed from an increase in the volume of Paid in Capital from member banks to the Boston Fed. By statute member banks have to set aside 6% of their capital to be members of the Federal Reserve System. The requirement is that only 3% or half of the 6% actually has to be invested in the Fed, the other 3% is sort of on call.


During the week ended February 1, 2012 an additional $379 mln of capital was paid in by member banks of the Boston District.


Also by statute the Federal Reserve Bank most maintained a Surplus equalled to the paid in capital of member banks. Thus the Boston Fed had to inject a matching $379 mln in capital. This increased the overall Paid in Capital of the Boston Fed to $1.322 mln.


The matching injection of capital by the Boston Fed came at the expense of the IOFRN accrual. In other words, the Boston Fed did not suffer a loss in the traditional sense, but had to retain $379 mln in earnings that they didn't have immediately on hand.


Without this $379 mln capital injection, the IOFRN accrual would have been comfortably positive. Welcome to the world of Fed accounting.

Welcome indeed, to a world where Fed hedge funds always make "profits" (until they don't), where accounting practices pull money out of Fed's communicating liability vessels (until all of them are empty), and where even a loss is somehow a profit.


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