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Thursday, January 28, 2010

Fed exposed

The risk faced by the Fed. Investment banks are being deleveraged; but the Fed got leveraged up:

The Federal Reserve's blowout 2009 profit is no reason to cheer. Rather, it is a reminder of the dangers inherent in the extraordinary policies the central bank has pursued during the credit crunch.

[FEDHERD]

Last year, the Fed earned $52.1 billion, with most of that income coming from interest-payments on bonds that it bought during the year to shore up the economy and credit markets.

Anyone with access to printing presses could have racked up similar gains. But the Fed's purchases leave it exposed. Its assets are 43 times its capital, compared with 15 times at Goldman Sachs. As a result, its equity could be wiped out by just a 2.8% drop in the value of its Treasurys and securities issued by Fannie Mae and Freddie Mac. True, the Fed could hold on to those securities and ride out any losses, and retain earnings to boost capital, but what self-respecting central bank wants to risk a negative net worth?

Even the fact that the Fed is, as usual, paying most of its profit to the Treasury isn't good news. It means the Treasury is paying almost no interest on a large slug of debt purchased by the Fed. That can only chip away further at fiscal discipline.