Fed’s wondrous printing press profits

January 14, 2010


— James Saft is a Reuters columnist. The opinions expressed are is own. —

Now finally we see what it takes to be a profitable bank with no capital worries and secure funding: own a printing press.

Sadly, since it is the Federal Reserve showing record $46 billion profits last year we have to conclude that, though it is a fool-proof plan, it’s not really scalable.

Combine news of the Fed’s biggest profit in its 95-year history with a report from the Troubled Asset Relief Program that its investments in banks are now showing a $7 billion gain and you’d be forgiven for concluding that this whole bailout malarkey is the next best thing to striking oil.

The two notional profits are of course related and prove little more than that if you have bottomless pockets you can make the price of a given asset rise. And while the trick for the Fed will be in how it exits its currently profitable positions, the real costs are more complicated and potentially much greater.

The means by which the Fed turned this magnificent profit are eerily similar to what Wall Street has been practicing: they grew their balance sheet and took on more risk.  Its profits were generated by two related moves: it bought far more bonds than it had in the past and, perhaps more importantly, it bought bonds of lower quality as part of the rescue efforts. Those risky bonds have risen in price, as anything that the Fed decided to start buying in size would, be they baseball cards, Florida time shares or limited edition commemorative plates.

Granted, the decision to channel credit into specific parts of the economy was taken under great pressure and in the face of grave dangers. Even so, there is no doubt that doing this exposed the Fed and the rest of us to major new risks.

Elements within Congress were not best pleased with a Fed that seemed, in allocating credit to specific areas, to be poaching on Congress’s traditional turf of controlling expenditures. There is a direct line between that profitable investment and the plan to subject the Fed to an audit and other greater oversight. This is a slippery slope and one that in other countries has ended up with a compromised central bank and inflation.

It would be a great and terrible irony, then, if the Fed ended up, even if by accident, selling its birthright of independence for the bowl of soup of getting out of one crisis.


Of more immediate concern will be how the Fed manages to exit its positions without upsetting any apple carts. Cessation of Fed buying in the mortgage market will drive effective rates higher for home buyers if in coming months the bank does not decide to continue its program. Selling would be even worse, and so I’d expect that the Fed manages its portfolio passively, allowing many bonds to mature and be retired. Actually, given the state of the U.S. economy, I think the Fed will have to figure out how to generate more profits in 2010.

As for the TARP, a report issued this week shows that its investments in banks are now worth about $141 billion, up from the $134 billion the Treasury paid. This is better than the alternative, but it misses some key facts. The profit of seven billion is pretty small beer for a rescue that kept at least some major banks alive.

It also excludes the governments far less successful foray into insurance; the American International Group investment is worth about $30 billion less than it cost, not even including billions in derivatives contracts which were paid out at an absurd 100 cents on the dollar.

Today President Barack Obama proposed Wall Street banks pay up to $117 billion to reimburse taxpayers for the financial bailout. That may have merit, but is not likely to solve the prime problem of leverage.

Efforts to reflate asset markets and then look the other way while insolvent banks earn enough to survive are working, as they’ve worked in the past.

Unfortunately we’ve seen what “working” looks like; the banks and the risks get bigger and eventually it all topples over.
If nothing is done to stop this, these profits, like those of Lehman Brothers and Bear Stearns, will look even more paltry in five years’ time then they do today.

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