Fat Fed Profits Do Not Create a Healthy Economy

1) Inflate the size of my balance sheet by 2.5x over last year, all through borrowing at really low rates.

2) Increase my interest spreads by ~50% over last year.

means:

3) I only increased my profits by ~50% over last year??!  🙁  I would have thought that profits would have more than tripled.

Such is life for the Fed.  The crisis was a time that led me to write pieces like The Liquidity Monopoly, where the Fed, FDIC, and Treasury played favorites in the economy, and starved the portions of the economy not dominated by large firms, particularly with banks and autos.

My main point is that the Fed should have earned a lot more.  Where did it all go?  It will be interesting to see a detailed rendering of the Fed’s finances when this is done.  Did they realize losses on some of the assets that they bought?

My friend Peter Eavis of the Wall Street Journal agrees.  Or, read Felix, and then read the exchange between my two friends Alea and Kid Dynamite.  Alea knows more, but I like KD’s spirit.

The Fed has become more like the banks that it regulates.  They are taking on credit risk, duration risk, convexity risk, etc.  And being a government institution, they don’t have good incentives for knowing how to price risk.

So, when I see the Fed’s seniorage profits up only 50%, I am not impressed.  The Fed doesn’t mark to market, so we really don’t know the true performance.  Also, remember that seniorage profits are a hidden tax on savers, would earn a higher yield if the government provided less financing.

Part of why we end up in an economic funk is that we finance dud assets at favorable rates, so capital does not get redeployed to better uses.  Aside from that, cheap leverage creates a yield frenzy over healthy assets, so that they can become over-levered as well.  Examples are numerous:

To me it is no great achievement that the financial markets are doing well while the real economy is in the tank (Unemployment, Production).  That is the nature of what happens when credit is force-fed into an economy, even leaving aside the problems of cronyism.  There should be no optimism over the large profits realized by the Fed; it may defray our taxes, but on net, the policies have not helped create a healthier real economy.