The Fed's $3.5T QE Purchases Have Generated $469B For The U.S. Treasury And Become One Of The Largest Sources Of Government Revenue

by: Mark J. Perry

The Federal Reserve just released its annual income statement for 2014, including details on its annual distribution of "residual earnings" to the US Treasury. Last year the Fed earned net income of $101.5 billion, primarily from "$115.9 billion in interest income on securities acquired through open market operations (U.S. Treasury securities, federal agency and government-sponsored enterprise (GSE) mortgage-backed securities (MBS), and GSE debt securities).

Note that "acquired" means that the Fed was able to purchase about $474 billion in securities last year in its "open market operations" without any real assets, deposits or money, bringing its total portfolio of securities "acquired" to $4.236 trillion at year end 2014, see red line in chart above. The "acquisition" of $4.236 trillion in marketable securities was mostly the result of the Fed's monetary expansion known as QE1, QE2 and QE3 that started in 2008 in response to the Great Recession. At the end of 2007, the Fed held "only" about $750 billion in Treasury securities, which then grew to a portfolio of almost $4.25 trillion by December 2014 after the Fed "acquired" almost $3.5 trillion in Treasury securities ($1.7 trillion in purchases from 2008 to 2009) and mortgage-back securities ($1.75 trillion from 2009 to 2014).

That's how expansionary monetary policy (including QE) works - the Fed uses what I call its "magic check book" to purchase securities in the open fixed-income market by writing checks to individuals, organizations and/or financial institutions on an account that has no funds. If a private party tries to acquire assets that way, it's called check forgery, writing a bad check, or bank fraud; when the Fed does it, it's called "monetary policy" or "open market operations" or "acquiring securities" or "QE."

On its $4+ trillion portfolio of fixed-income securities, the Fed earned an average interest rate of about 3%, which generated the $116 billion of interest income last year for the Fed. To provide context for that amount of interest income, consider that all nearly 7,000 FDIC-insured US banks together earned only $116 billion in net income during the first three quarters of 2014, and will probably end up with about $155 billion in net income for the whole year.

After accounting for operating expenses and other costs (currency issue, interest expenses, dividends, etc.), the Fed paid "residual earnings" to the US Treasury last year of $98.7 billion, see blue bars in chart above. That annual Fed distribution to the Treasury was the largest ever, and brings the total amount distributed since QE started in 2008 to almost half a trillion dollars - $469 billion in the six years from 2009 to 2014.

That was a point made Monday by the WSJ in its staff editorial "The Fed Cash Machine," which pointed out that QE has made the Fed's annual distriubtion of "residual earnings" one of US Treasury's largest single revenue sources:

For perspective, the entire federal budget deficit for fiscal 2014, which ended in September, was $483 billion. Without the Fed's windfall, it would have been nearly $100 billion more. Corporate income tax revenue in 2014 was $321 billion, so the Fed turned over nearly 30% of the amount provided by every American corporation.

Treasury is spending the Fed's windfall, naturally, which means that when the QE boom ends the country will have to spend that much less or find the revenue somewhere else. The danger is that politicians are getting used to the money, which is one more reason for the Fed to begin winding down its balance sheet sooner rather than later.

Bottom Line: While the record transfer of almost $100 billion from the Fed to Treasury last year has gotten some media attention, what hasn't been reported, except by the WSJ Monday is this: The monetary expansions known as QE1, QE2, and QE3 ended up being a gigantic transfer of wealth from the private sector to the public sector. By "acquiring" almost $3.5 trillion in assets with a "magic checkbook" that were previously held largely by private investors and the private sector, those trillions of dollars in Treasury and MBS securities, along with the billions of dollars in interest income those securities generate, got transferred to the Fed, which has then transferred almost half a trillion dollars in residual interest earnings to the US Treasury in the last six years.

Q: Is that fair/accurate to describe QE1, QE2 and QE3 as monetary policies that ultimately transferred billions of dollars in private wealth to the US Treasury via the Fed? Or is it more accurate to describe it as printing money to finance the government's budget deficit disguised to look like monetary policy, since the bond holders got paid for their securities? (Thanks to Jeff Dorfman for help with that second description.)