Accounting Change Lets Federal Reserve Offload Toxic Assets

01-22-2011 • EconomicPolicyJournal.com

[According to]Raymond Stone, managing director at Stone & McCarthy in Princeton, New Jersey, "An accounting methodology change at the central bank will allow the Fed to incur losses, even substantial losses, without eroding its capital." The change essentially allows the Fed to denote losses by the various regional reserve banks that make up the Fed system as a liability to the Treasury rather than a hit to its capital. It would then simply direct future profits from Fed operations toward that liability... "Any future losses the Fed may incur will now show up as a negative liability as opposed to a reduction in Fed capital, thereby making a negative capital situation technically impossible," said Brian Smedley, a rates strategist at Bank of America-Merrill Lynch and a former New York Fed staffer. "The timing of the change is not coincidental, as politicians and market participants alike have expressed concerns since the announcement (of a second round of asset buys) about the possibility of Fed 'insolvency' in a scenario where interest rates rise significantly," Smedley and his colleague Priya Misra wrote in a research note. Bottom line: We all knew the Fed was going to have to do some kind of monkey business to deal with all the junk securities it purchased, here it is: Negative liabilities. Yes, only at your local Fed.