Fed accounting
This page delves into the mysteries of Fed accounting and the tricky issue of whether the Fed may be going broke.
The value of a central bank
What is the value of a central bank? Since central banks do not have publicly traded stock, economists have devised various approaches to answering this question. None of these are particularly straightforward. A paper by two economists at the Bank for International Settlements, David Archer and Paul Moser-Boehm, offers an excellent guide to the relevant concepts:
Some aspects of central bank accounting emphasized by Archer and Moser-Boehm are
Since the value of a central bank derives from the liquidity of its liabilities, calculation of its true value ("comprehensive net worth") must incorporate an estimate of the bank's discounted future profits from liquidity provision (often called seigniorage). This franchise value typically dwarfs the equity numbers reported in official central bank accounts. Calculating this value involves projections into the far future, and estimates can vary widely depending on assumptions employed.
Hence, a central bank's net worth = [its conventional equity] + [an estimate of its franchise value]
Who profits from the Federal Reserve?
A small portion of Fed income goes to pay dividends to commercial banks who, by law, own stock in the Federal Reserve Bank in the district where they reside.
A larger portion goes to the Fed, to fund its operations.
Under normal circumstances, the bulk of Fed profits net of (1) and (2) are then returned to the United States Treasury. Transfers of Fed profits to the Treasury are called remittances. Thus, the US Treasury can thus be thought of as the beneficial owner of the Fed.
Currently, however, the Fed is losing money (it lost $114 billion in 2023), a situation that is seen as temporary. In such situations, Fed accounting rules (explained below) call for the Fed to appropriate some of the value that would normally accrue to the Treasury.
OK, so what is the value of the Fed?
Official accounts of the Federal Reserve, such as its weekly (unaudited) balance sheets (H.4.1) and its annual audited financial statements, do not attempt to estimate the comprehensive net worth of the Fed. Instead, they report what amounts to the Fed's equity position, $42.85 billion in the most recent annual statement (see Combined Statements of Federal Reserve Banks, p.3). What missing is an estimate of the Fed's franchise value. Such estimates do however occasionally show up in studies by Fed and other economists.
A 2018 study by Fed economists estimates the Fed's franchise value at $493 billion (see "PDV of remittances," Table 1, page 25). Because the Fed's balance sheet has expanded by about 70 percent since early 2018, this figure may be taken as a lower bound on the Fed's current franchise value, recent losses aside. A reasonable upper bound may be around $1 trillion. While this is a large number, it is not infinite. The market capitalizations of publicly traded companies such as Apple and Microsoft are notably larger, currently around $3 trillion.
How is the value of the Fed divided between the Fed and the US Treasury?
Under normal circumstances, the Fed is quite profitable and its profits accrue to the US Treasury. Since September 2022, the Fed has been losing money because interest paid on its liabilities (reserves, reverse repurchase agreements) exceeds interest on its assets (primarily US Treasuries and agency mortgage backed securities). These losses are recorded as negative remittances and accumulated losses are recorded as a deferred asset. As of this writing, this deferred asset has reached $157 billion; see H.4.1 release for March 21, 2024, Table 6. The deferred asset shows up as a reduction in the liabilities of the Federal Reserve Banks.
Under Fed accounting rules, the significance of the deferred asset is the following: until the Fed accumulates enough earnings to amortize its "borrowing" from future earnings via the deferred asset, the Fed will not resume remittances to the Treasury. In plainer English, through its accounting rules, the Fed has allocated $157 billion of its franchise value from the Treasury to itself, still however leaving $340 billion+ for the Treasury.
Fed accounting versus normal (private sector) accounting
In the private sector, a firm that had accumulated $157 billion in operating losses would probably be in trouble. A transparent treatment of such losses on the Fed's books would record these as subtractions from its equity, leaving the Fed with a negative equity of roughly $100 billion. Such an accounting treatment would be arithmetically equivalent to current Fed practice, but might not offer as good a look as using losses to reduce liabilities. The latter way of treating accumulated losses also delineates the portion of the Fed's value it has allocated to itself.
One of my Atlanta Fed colleagues pointed out that the Fed's treatment of its accumulated losses is somewhat like a private firm's treatment of tax losses: operating losses from one tax year can be carried forward to reduce taxes on the firm's profits in future years. So what the Fed is doing is carrying forward operating losses to reduce future "taxes" in the form of remittances. The big difference is that a private firm with deep tax losses cannot use such losses to fund its operations going forward. The Fed, being a central bank, does not worry about funding.
So is the Fed about to go broke?
A private sector firm with deep negative equity might struggle to fund its operations and could be forced into bankruptcy. This usual insolvency scenario does not apply to fiat money central banks, however, which can always create more money and so will always be able to fund themselves. A central bank can however fall into an unsustainable situation known as policy bankruptcy.
Policy bankruptcy occurs when a central bank's equity is so impaired that it cannot maintain its monetary policy, barring a capital injection. While the technical conditions for policy bankruptcy can be complicated (see for example this paper by Marco Del Negro and Chris Sims), a back-of-the envelope test is to calculate comprehensive net worth of the central bank. If this is negative, the central bank must either adjust its policies (run a higher inflation rate) or ask fiscal authorities for a capital injection.
So how close is the Fed to policy bankruptcy? As noted above, the Fed's "true" equity position is about -$100 billion. Its franchise value is on the order of $500 billion. This implies that the Fed currently has a comprehensive net worth of $400 billion or more, a seemingly comfortable distance from policy bankruptcy.