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Debunking a Fed Myth

On April 24, a story ran on Bloomberg that stated:

The Federal Reserve took on more than $74 billion in subprime mortgages, depreciating commercial leases and other assets after Bear Stearns Cos. and American International Group Inc. collapsed.

In its biggest disclosure of the securities accepted to stabilize capital markets, the Fed said yesterday it had unrealized losses of $9.6 billion on the assets as of Dec. 31. The bonds, swaps and notes were taken in from Bear Stearns, once the fifth-biggest Wall Street firm by capitalization, and AIG, which had been the world’s largest insurer.

The losses on securities backed by assets such as home loans in Florida and California signal that U.S. taxpayers may be forced to reimburse the central bank through the Troubled Asset Relief Program, according to Christopher Whalen, managing director of Torrance, California-based Institutional Risk Analytics.

“The numbers basically confirm that Treasury is going to have to take some TARP money and reimburse the Fed,” said Whalen, whose financial-services research company analyzes banks for investors. “It is essentially up to the Treasury to get the Fed out of this.”

 

One must realize that the Treasury will not have to pony up any cash for the shortfalls.  The Fed ultimately can reduce the amount it pays the Treasury from its "excess earnings". 

From the Federal Reserve Act : "The Federal reserve banks shall transfer from the surplus funds of such banks to the Board of Governors of the Federal Reserve System for transfer to the Secretary of the Treasury for deposit in the general fund of the Treasury" (Section 7 - Division of Earnings).

But wait, it goes on to say:

"The net earnings derived by the United States from Federal reserve banks shall, in the discretion of the Secretary, be used to supplement the gold reserve held against outstanding United States notes, or shall be applied to the reduction of the outstanding bonded indebtedness of the United States under regulations to be prescribed by the Secretary of the Treasury."

 

Ok, think TS Tim is gonna buy gold?  Reduce the outstanding indebtedness?  Hmmm, things get kinda sketchy here.  Just wait folks, the accounting voodoo is gonna surpass Enron.

Disclosure:  no positions