in which my ignorance of finance is revealed


Not to me, anyway.  But I think that perhaps I could just use some further explanation from people smarter than myself about how the financial system works.  So consider this a plea for help — one that I would’ve issued over Twitter, if Twitter’s character limit was 2300% larger.

Anyway, the problem: this article makes the case that the Federal Reserve has been having a very profitable year:

The Fed will return about $45 billion to the U.S. Treasury for 2009, according to calculations by The Washington Post based on public documents. That reflects the highest earnings in the 96-year history of the central bank. The Fed, unlike most government agencies, funds itself from its own operations and returns its profits to the Treasury.

The numbers are good news for the federal budget and a sign that the Fed has been successful, at least so far, in protecting taxpayers as it intervenes in the economy — though there remains a risk of significant losses in the future if the Fed sells some of its investments or loses money on its stakes in bailed-out firms.


Much of the higher earnings came about because of the Fed’s aggressive program of buying bonds, aiming to push interest rates down across the economy and thus stimulate growth. By the end of 2009, the Fed owned $1.8 trillion in U.S. government debt and mortgage-related securities, up from $497 billion a year earlier. The interest income on those investments was a major source of Fed profits — though that income comes with risks, as the central bank could lose money if it later sells those securities to reduce the money supply.

The Fed also made money on its emergency loans to banks and other firms and on special programs to prop up lending, such as one that supports credit cards, auto loans, and other consumer and business lending. Those programs impose interest and fees on participants, with the aim of ensuring that the Fed does not lose money.

So, okay, some of this makes sense: the emergency loan programs involve third parties and can, in fact, produce profit via interest on the loans.

But two questions.  First: as the article states, these earnings will go back to the Treasury, which will be “good news for the federal budget” — except that much of the earnings are attributed to gains from purchased federal debt — bonds paid out by the Treasury.  So, uh, how is this “profit” not completely circular?  I suppose that perhaps it represents money that we thought we had spent but hadn’t.  Still, the Post’s presentation of the issue seems very strange.

Second: what is the article talking about, anyway? Not to toot my own project’s horn too much, but we’ve got this nifty visualization of fed holdings based on their weekly H.4.1 reports, and it’s just not the case that the fed has increased the amount of Treasury securities it holds.  There was a dip, but we’re basically back at 2007 levels.  The fed’s portfolio has gotten much larger thanks to the bailout, but the real story looks to be its still-expanding investment in mortgage-backed securities.

I’m just the tech guy, so I hesitate to go much further out on this limb.  But I think Neil Irwin could’ve done a lot more to distinguish between Treasuries and MBSes, and what they mean for the Fed’s holdings.  Help me Ryan Avent, you’re my only hope!

MORE: The first comment on Felix Salmon’s coverage of this article is helpful: basically, this is good news because it’s not bad news.  Perhaps it’s a bit silly to think of profit from Treasury securities as a windfall for the government, but at least the Fed managed to keep prices from collapsing, which could’ve easily happened.  I’m still confused by how the article presents its thesis, though.

About the author

Tom Lee


  • You’ve basically got it. If the Fed didn’t own those Treasuries, the interest income would leave the government and represent a net hit to the budget. The large new holdings of MBS are generating a lot of income for the Fed, and it wasn’t clear that they would (it is assumed that a lot of junk mortgages are backing those securities). The MBS still aren’t worth very much, and if the Fed sells them to reduce the size of its balance sheet and mop up cash from the economy, then it will likely take a loss on them — they’ll fetch less than the Fed paid. But in the mean time, the coupon payments the Fed is receiving are generating some nice earnings, which will likely cover the eventual loss on the sale and then some (unless the economy takes another turn for the worse).

By Tom Lee