Critics of the Federal Reserve often accuse it of printing money. What they may not realize is that the Fed has been printing profits, too.
The Fed's “quantitative easing” programs are controversial because the Fed has purchased huge quantities of bonds and distorted the ordinary functioning of financial markets in ways that are difficult to gauge. Those bond purchases have helped push interest rates down and stock prices up, but they could also produce inflation, asset bubbles and other unforeseen problems.
In the meantime, however, quantitative easing has been enormously profitable for the Fed — and for Uncle Sam, which garners all profits from the central bank. The Federal Reserve earned nearly $90 billion in 2012, after accounting for all its expenses. If the Fed were a corporation, its chairman, Ben Bernanke, would be the most celebrated CEO in the world, sitting atop annual profits more than twice what Apple or Exxon earn.
New analysis by economists at the New York Fed compares the central bank’s current portfolio of assets — which produced that eye-popping income — with a “counterfactual” scenario that looks more like traditional Fed operations. The counterfactual scenario assumes that, during the past five years, the Fed lowered short-term rates the same as it did in reality, but engaged in no quantitative easing, bailout assistance or “toxic asset” purchases such as those involving portfolios from Bear Stearns and AIG (AIG).
Under that more traditional scenario, the researchers estimate, the Fed would have generated a profit of about $85 billion from 2007, when QE began, through 2012. In reality, the Fed earned $325 billion during that time, or $240 billion more than it would have under business as usual. The Fed's profits typically come from interest paid on Treasury securities it holds. Adding to that during the past five years has been additional interest income from bonds plus higher rates on longer-term securities, which the Fed has been buying more of.
Had the Fed stayed the course back in 2007, its portfolio of securities would total about $1.3 trillion today, the researchers estimated. Instead, it's at more than $3.3 trillion. What worries some investors is what will happen as the Fed begins to reduce the size of its mammoth portfolio, something that has never happened before.
Even if the Fed ends QE in 2014, as many analysts expect, it will retain an enlarged asset portfolio for years, since it will sell assets slowly or perhaps even hold on to to many of those bonds until they mature. By 2025, the Fed’s total profits under QE will amount to about $820 billion, the Fed researchers estimate, or $315 billion more than under the counterfactual scenario.
All the Fed’s profits go to the Treasury, and that’s real money that lowers the federal deficit and helps reduce the need for tax increases. And even by Washington’s inflated standards, $315 billion is a lot of cash. Consider this: It's more than half the Pentagon’s annual budget. The sequester that caused so much hand-wringing earlier this year involved just $110 billion in annual spending cuts. The tax hikes on the wealthy that gave Republicans heart palpitations at the start of 2013 amounted to only $62 billion per year.
The Fed could be an unreliable profit center for the government, however. The Fed’s income is likely to drop sharply after 2015, as it sells off securities and earns less in interest income and also pays more interest on bank reserves it holds as rates presumably rise. Under the more traditional scenario, the Fed’s income would begin to rise after 2015 rather than fall, even though total income by 2025 would remain far below the real-world figure.
The Fed has attracted a lot of criticism from Capitol Hill, especially from Republican lawmakers who feel it has overstepped its bounds and created too much risk of inflation. Yet the Fed, ironically, has made life easier for members of Congress who would face even bigger deficits if the Fed were more passive.
Still, at the Fed, billions in government revenue is just a fringe benefit, since the bank’s mission is to keep inflation and unemployment at reasonable levels — not to make money. It’s a strange predicament. The most profitable institution in the nation isn’t even supposed to earn money, while many private-sector firms that exist purely for profit are struggling to turn one. It’s good to be the Fed.
Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.