STOCK MARKET WATCH - Wednesday, 11 January 2012

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23. Fed Turns Over $77 Billion In Profits to the Treasury

http://www.nytimes.com/2012/01/11/business/economy/fed-returns-77-billion-in-profits-to-treasury.html?ref=business

The Federal Reserve said on Tuesday that it contributed $76.9 billion in profits to the Treasury Department last year, slightly less than its record 2010 transfer but much more than in any other previous year. The Fed is required by law to turn over its profits to the Treasury each year, a highly lucrative byproduct of the central bank’s continuing campaign to stimulate economic growth. Almost 97 percent of the Fed’s income was generated by interest payments on its investment portfolio, including $2.5 trillion in Treasury securities and mortgage-backed securities, which it has amassed in an effort to decrease borrowing costs for businesses and consumers by reducing long-term interest rates. Through those purchases, the central bank has become the largest single investor in federal debt and securities issued by the government-owned mortgage finance companies Fannie Mae and Freddie Mac. As a consequence, most of the money flowing into the Fed’s coffers comes from taxpayers.

But Fed officials note that this cycle — payments flowing from Treasury to the Fed and then back to the Treasury — still saves money for taxpayers because those interest payments otherwise would be made to other investors. “It’s interest that the Treasury didn’t have to pay to the Chinese,” the Fed’s chairman, Ben S. Bernanke, half-jokingly told Congress last year.

The scale of the transfers grew rapidly after the financial crisis. The Fed made an average annual contribution to the Treasury Department of $23 billion during the five years preceding the crisis. In the years since 2007, the Fed’s average contribution has more than doubled to $54 billion. The Fed transferred $79.3 billion in 2010. Its investment portfolio grew again in 2011, approaching $3 trillion, but profits fell modestly as the Fed reduced some more lucrative holdings, like its support for the insurance company American International Group, and expanded its holdings of low-yield government debt. Notwithstanding its conservative investment portfolio, the central bank remains highly profitable because of its unique business model. Rather than paying for funding, it simply creates the money that it needs at no cost. The return on its investments, as a result, almost all flows directly to the bottom line. Still, the model is not foolproof. The Fed could decide to undermine its own profitability if it concluded that the pace of inflation was increasing. Fed officials have said that they would respond to inflationary pressures through a combination of selling assets and raising short-term interest rates, which would have the effect of undercutting the value of those assets just as they were being sold. The Fed also could conclude that it needed to pay higher interest rates to banks that keep reserves on deposit with the central bank, to discourage withdrawals of that money.

In addition to the money sent to the Treasury, the Fed spent $4.5 billion on its own operations, including its expanded role as a regulator of the largest financial companies. The 2010 law overhauling financial regulations also requires the Fed to provide funding for two new agencies, the Consumer Financial Protection Bureau and the Office of Financial Research. The bill totaled $282 million last year. Other federal financial regulators are financed by the industries that they oversee. Both systems are intended to shelter regulators from political pressure...The results reported Tuesday are preliminary. The 12 regional banks that compose the Federal Reserve system will publish final financial results in a few months. If there is a change in estimated profits, the Fed will adjust the amounts that it pays to the Treasury this year. The contributions are made weekly.