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The Fed’s accounting change

And you thought they WEREN’T going to try and FRAUD their way out of this?  How silly of you!

John

http://www.zerohedge.com/article/accounting-gimmick-makes-fed-insolvency-impossible

“Creative Accounting” Makes Fed Insolvency Impossible

Submitted by Tyler Durden on 01/20/2011 09:34 -0500

To all who thought that the FASB gives leeway only to banks when fudging
their numbers, and boosting their equity capital in ways previously
unheard of, we have a surprise. The latest entrant in the “accounting
gimmickry” club is none other than the Fed. And since the Fed is not
auditable by anyone, it gives itself permission to change and bend the
rules in any way it desires. Following on recent speculation that the
Fed could in theory have a equity capital deficiency due to its massive
asset book, and its tiny equity buffer, both discussed many times
previously on Zero Hedge (here and here), the Fed recently announced as
part of its January 6 H.4.1 release “an important accounting policy
change with the release of its weekly H.4.1 report on January 6 that
effectively prevents it from facing a negative capital position even in
the event that it incurs substantial losses.” Here is how Bank of
America’s Priya Misra explains this curious, and most certainly
politically-motivated development: “The Fed remits most of its net
earnings on a weekly basis. Prior to this accounting change, any
unremitted earnings due to the Treasury would accrue in the “Other
capital” account, but will now be shown in a separate liability line
item called “Interest on Federal Reserve notes due to the Treasury.” As
a result, any future losses the Fed may incur will now show up as a
negative liability (negative interest due to Treasury) as opposed to a
reduction in Fed capital, thereby making a negative capital situation
technically impossible regardless of the size of the Fed’s balance sheet
or how the FOMC chooses to tighten policy.” And there you have it:
instead of reducing the left side of the balance sheet upon the
incurrence of losses, the Fed has decided to fudge the right side. And
presto. No more possibility of insolvency ever again. Which only means
that the Fed’s now ridiculous DV01 of just under $2 billion will in no
way prevent the world’s biggest hedge fund from taking proactive steps
to actually mitigate rate risk, and in fact will likely encourage it to
gamble even more with taxpayer capital.

More from Bank of America:

Accounting change prevents a Fed “insolvency” scenario

[charts]

Mounting concerns about Fed “insolvency” post QE2

The Fed announced an important accounting policy change with the
release of its weekly H.4.1 report on January 6 that effectively
prevents it from facing a negative capital position even in the event
that it incurs substantial losses. The timing of the change is not
coincidental, as politicians and market participants alike have
expressed concerns since the announcement of QE2 about the possibility
of Fed “insolvency” in a scenario where interest rates rise
significantly. These concerns have prompted some observers to suggest
that the Fed may be unable to tighten policy sufficiently once the
economy recovers, since doing so could result in a negative capital
situation and the need for a Treasury “recapitalization,” thereby
compromising the Fed’s political independence.

Fed required to remit profits to Treasury (not build capital)

Since 1947, the Board of Governors has required that the Reserve
Banks remit nearly all net earnings to Treasury. Remittances are roughly
equal to income from loans and securities holdings less operating
expenses, interest paid on depository institutions’ reserve balances,
dividends paid to member banks, and any amount necessary to top up the
Fed’s capital. Fed remittances have surged since late 2008, reflecting
its aggressive balance sheet expansion in the context of nearzero term
interest rates (Chart 1). The Fed could potentially incur losses,
however, if short term rates rose such that the interest paid on bank
reserves exceeded the interest income of the System Open Market Account,
or SOMA portfolio. Similarly, the Fed could face capital losses if it
were to sell securities below their original purchase price (Chart 2).
Note that the SOMA portfolio is not marked to market, but is reported on
a par-value basis each week, so higher yields would only impact Fed
earnings in the context of asset sales.

Accounting change prevents negative Fed capital situation

The Fed remits most of its net earnings on a weekly basis. Prior to
this accounting change, any unremitted earnings due to the Treasury
would accrue in the “Other capital” account, but will now be shown in a
separate liability line item called “Interest on Federal Reserve notes
due to the Treasury.” As a result, any future losses the Fed may incur
will now show up as a negative liability (negative interest due to
Treasury) as opposed to a reduction in Fed capital, thereby making a
negative capital situation technically impossible regardless of the size
of the Fed’s balance sheet or how the FOMC chooses to tighten policy.
There will be no change to the current practice of remitting profits to
the Treasury on a weekly basis, but the Fed will postpone any
remittances if this line item becomes negative. In effect, any losses
will be offset against future Fed remittances to the Treasury. In our
view, this policy appears to be a clever solution to the Fed’s
inability to provision for potential future losses by retaining earnings
today. We expect it to mitigate – though not fully allay – concerns
about Fed solvency.

And the full notification in the January 6 H.4.1 release:

The Board’s H.4.1 statistical release, “Factors Affecting Reserve
Balances of Depository Institutions and Condition Statement of Federal
Reserve Banks,” has been modified to reflect an accounting policy change
that will result in a more transparent presentation of each Federal
Reserve Bank’s capital accounts and distribution of residual earnings to
the U.S. Treasury. Although the accounting policy change does not
affect the amount of residual earnings that the Federal Reserve Banks
distribute to the U.S. Treasury, it may affect the timing of the
distributions. Consistent with long-standing policy of the Board of
Governors, the residual earnings of each Federal Reserve Bank, after
providing for the costs of operations, payment of dividends, and the
amount necessary to equate surplus with capital paid-in, are distributed
weekly to the U.S. Treasury. The distribution of residual earnings to
the U.S. Treasury is made in accordance with the Board of Governor’s
authority to levy an interest charge on the Federal Reserve Banks based
on the amount of each Federal Reserve Bank’s outstanding Federal Reserve
notes.

Effective January 1, 2011, as a result of the accounting policy
change, on a daily basis each Federal Reserve Bank will adjust the
balance in its surplus account to equate surplus with capital paid-in
and, in addition, will adjust its liability for the distribution of
residual earnings to the U.S. Treasury. Previously these adjustments
were made only at year-end. Adjusting the surplus account balance and
the liability for the distribution of residual earnings to the U.S.
Treasury is consistent with the existing requirement for daily accrual
of many other items that appear in the Board’s H.4.1 statistical
release. The liability for the distribution of residual earnings to the
U.S. Treasury will be reported as “Interest on Federal Reserve notes due
to U.S. Treasury” on table 10. Previously, the amount necessary to
equate surplus with capital paid-in and the amount of the liability for
the distribution of residual earnings to the U.S. Treasury were included
in “Other capital accounts” in table 9 and in “Other capital” in table 10.

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