A lot of people have been saying the Fed can't raise rates that much or, the market won't let the Fed raise much or the economy won't or whatever. That's all bunk. None of those things matter, however, we can construct a model of just how far the Fed can raise rates, based on the knowledge that they must pay interest on reserves OUT OF THEIR OWN EARNINGS!
First let me mention that the Fed turned over $100 billion to the Treasury in FY 2015, so we know how much the Fed earns: $100 billion. That's how much it earns so that's how much it can pay.
On a portfolio of assets of $4.5 trillion, the Fed is earning about 2.2%. Actually, maybe a little bit more because its making most of its money on holdings of government securities ("those babies" in the words of Alan Simpson) and that amounts to $4.2 trillion so that's a return of 2.4%.
There's $4.5 trillion in reserves (equivalent to the Fed's assets by definition).
So the answer to how high the Fed can raise is 2.4%. That's it. After that it's out of money and you know DAMN WELL that there is no way Janet Yellen would go to Congress to ask for money to pay interest. NO WAY.
When the Fed didn't have to pay interest on reserves it was the Treasury's expense, but Ben Bernanke, in all his wisdom, convinced Congress back in 2008 that HE wanted that expense for some reason. Not exactly a Donald Trump, art of the deal, move. Before that, the Fed had the power to raise to infinity. Again, Treasury was on the hook to pay.
So, there's the answer to that question for anyone who is wondering. The maximum the Fed can raise is 2.4%. After that, it's literally out of money.
Feel free to distribute.
https://en.wikipedia.org/wiki/Factoring_(finance)
ReplyDeleteI'd say its even less than that, since the Fed also has to pay out the 6% dividend to all its member banks, pay its own expenses, and now those of the CFPB.
ReplyDeleteQuestion is a what point does the Fed try to raise by selling of its portfolio? This might have the odd effect of raising longer term rates while leaving shorter term rates unchanged.
No talk at all about that Justin...
ReplyDeleteimo they are relying on the interest from US homeowners to operate as the USTs might be at about a breakeven....
So they might be able to let USTs run off but look for them to keep the MBS "to support US homeowners and the housing industry.... blah, blah...." as they have the juicy yields...
The Fed doesn't have to pay interest on reserves out of its own earnings. Janet Yellen doesn't have to ask for a dime. If the Fed has negative net earnings in any given year that just means the treasury gets no disbursement. It's completely up to the fed. If the Fed chooses to restrict the aggregate interest payments within its estimated earnings, that is just a monetary policy choice, not a requirement.
ReplyDeleteThere is nothing in the authorizing legislation that requires interest payments on reserves to be limited by Fed earnings:
https://www.congress.gov/109/plaws/publ351/PLAW-109publ351.pdf
This is still the best paper on the Fed's exit strategy:
ReplyDeletehttp://www.federalreserve.gov/pubs/feds/2013/201301/revision/201301pap.pdf
Also, note that when the Fed raises rates it will begin to sell securities from its portfolio, thus draining reserves. This lowers the Fed's interest expense at any given rate of IOR, and increases its income.
A $300k mortgage's monthly payment would be roughly 30% greater with a 2.5% move in rates. So the Fed doesn't give two shits about home ownership and wants homes to depreciate significantly?
ReplyDeleteI suspect that the Fed is super-sensitive to the effect of the policy rate and yield curve on mortgage rates. They realize that the chief transmission mechanism is investment and s major component of that is RE, both residential and commercial.
ReplyDeleteInterestingly also, a lot of the dealing in RE has been cash transactions that don't involve borrowing, although that has now wound down and with it sales. There's still a lot of unused space and it's pretty predictable that if RE values rise, more properties will come on the market.
I don't see the Fed raising rates much anytime soon given the flat to disappointing numbers that are coming it now and the global economy seems to be rolling over.
I don't know if the Fed is allowed to have negative equity, Kervick. Do you know that for a fact?
ReplyDeleteMike, IIRC, this was arranged at the time that the Fed got permission to pay IOR, but I don't recall the ref offhand.
ReplyDeleteHere's something short on it from Peter Stella
ReplyDeleteWhat the Federal Reserve Can Learn from the Bank of Israel
The BOI consistently runs negative equity. Certainly Stanley Fisher knows this.
The decision in January 2011 to ensure that any future FR losses will be obscured as a deferred asset account is one case in point. Yes, this will prevent a future FR from showing negative equity, but it will do nothing to hide the fact that the FR will be running losses and that the FR has ceased transferring profit to the Treasury. Better that provisions for this eventuality be created now—see Stella (2009). But the FR has an awkward legal structure...the owners of each independent Federal Reserve Bank are the member commercial banks in their geographical district. It is those banks, not the Treasury who are legally responsible for covering any FR capital deficiency. This rather politically awkward problem may be averted by the deferred asset account. But will all the people be fooled all the time? I think not. Hence let us be grateful that someone who has openly had to deal with central bank losses and negative equity may come to be the Vice Chairman.
Mike, first of all, negative equity is not the same thing as negative income. The Fed could probably have negative income for several years before it ran down its total capital - which is currently at over $58 billion. There are regulations already set down governing how to account for income losses.
ReplyDeleteAs for losses that are big enough that they might lead to negative equity, how this is handled varies from central bank to central bank. The way it is handled by Fed accounting principles is that in the event of a net loss on the income statement, they create a "deferred asset" on the balance sheet counterbalancing the income loss - leading to a zero net change in capital due to income. In other words, the Fed would never have negative equity in accounting terms because it is allowed to to just make up and declare an asset sufficient in size to offset any balance sheet damage incurred by the income losses.
The reason the asset is "deferred" is because it is gradually converted into something actual by reducing the amount remitted to the treasury. So if the Fed had negative $10 billion in net income in 2018 and a positive $15 billion in comprehensive income in 2019, then in 2018 in would put a $10 billion deferred asset on its books to offset the $10 billion loss. Then in 2019, it would remit only $5 billion of its $15 billion in earnings to the treasury, and retain the additional $10 billion to convert the deferred asset into a real asset.
One reason it is able to do this so easily is that the Fed is not required by law to remit its net earnings after expenses and dividends to the treasury. This is purely a matter of discretionary Fed policy. It is however a discretionary policy that they have adhered to without exception for many decades (since the early 30's I believe). But the Fed doesn't have to ask for Congressional permission to alter its own discretionary policy. At any time it can begin to hold back remittances to make up for losses. It doesn't need to seek extra Congressional permission to do this.
So in other words, the Fed covers earnings losses by billing them against future remittances to the treasury. This is already established Fed policy. No new Congressional permission required. You could say that the treasury is "bailing out" the fed. But that is not actually accurate. The money the Fed remits to the treasury doesn't belong to the treasury until the Fed chooses to remits it. So in technical terms the treasury can't say the Fed is using "their money" to bail itself out.
If the Fed had negative income year after year, no doubt that would be a bit of a political mess. The tea partiers would be screaming that the Fed is broke. Others would be screaming that the policy is inflationary. But it really wouldn't impair Fed operations in any way. They would just keep piling up those deferred assets, and push off the time at which the treasury would begin to receive remittances again further and further into the future. If that day never came, it wouldn't matter operationally.
We have a central bank that is "independent within the government". Obviously Congress makes they laws. But they have pre-delegated an awful lot of operational independence to the Fed, and also set things up so that, as far as monetary policy goes, the Fed wears the pants in the Fed-Treasury relationship.
Yeah Tom that's like the left saying.. "that's what they did in Ecuador!" or some other second rate hell hole in support of a proposed policy... on second thought, if they say "well that's what they do in Israel!" the the libertarian morons in the John Hagee wing would probably agree in in millisecond....
ReplyDeleteAnyway, the higher they will raise will be 25bps to lower them again to achieve negative rates (the latests brightest idea of central banker monetarist moronfest) as things cool down and the market (housing/stocks/tech bubble) tops.
ReplyDeleteDan,
ReplyDelete"...Fed would never have negative equity in accounting terms because it is allowed to to just make up and declare an asset sufficient in size to offset any balance sheet damage incurred by the income losses."
Well what was the problem with the Maiden Lanes then?
Why did Bernanke state his regret and feel these were established as bad policy at the Fed?
Why did all the lefty blogs and media complain that the Fed was buying "toxic waste"? They created a whole lefty media enterprise cottage industry against "toxic waste" that the Fed allegedly bought....
If the Fed were to try that one again, then you would even see Naked Capitalism, Randy Wray, Bill Black, Michael Hudson, Zero Hedge, Washington Blog, Matt Taibbi, and all these other people protesting that the Fed is bankrupt too... right along with the other right gold bugs and other right libertarian whackos....
Who would be the Fed's allies in trying to spin that accounting politically? I cant think of anyone...
Dan for the Fed to sell that negative accounting outcome politically, it would be as hard politically as what we have been doing for years in trying to get people to think of the govt debt as non-govt savings... look how successful we have been...
ReplyDelete" note that when the Fed raises rates it will begin to sell securities from its portfolio, thus draining reserves."
ReplyDeleteDan there has been NO mention of this AT ALL.... NONE, ZERO, ZIP, NADA....
They are keeping the securities.... especially the MBS as those securities have always yielded more than the policy rate...
Matt, they have said that their plan is to let the MBS holdings decline gradually by not reinvesting principle repayments from the securities in the portfolio into the purchase of more MBS securities, but that they might sell some of those securities back to the public if they find that need to do so to reduce residual holdings.
ReplyDeleteThe biggest crackpots on the Fed "bankruptcy" front and complaints about toxic assets have been the right wing Zero Hedgies. For example:
http://www.zerohedge.com/news/2015-04-20/fed-study-finds-fed-insolvency-would-not-create-serious-problems
I would be amazed if Randy Wray would ever say at any time that the Fed is bankrupt.
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ReplyDeleteMatt the outcries from the left usually come because they are consider the government is steeping in to save banks WHILE keeping them private and unaccountable (at least the stuff that comes from NC or someone like Black or Wray), hand-holding for the financial industry without any accountability or prosecution.
ReplyDeleteThis has nothing to do with solvency, and all to do with accountability. The left prefers the solution to be an intervention of the state and the bankers not walking away and get their way as usual... Right wing solution is to let the financial system collapse and the FED/treasury etc. do nothing so they pay for their mistakes. The only thing they have in common is that both oppose the status quo solution ("bankers having the cake and eating them too"). You are conflating both positions.
The status quo is stupid, period, as it's demonstrated by the repeated transgressions of the law when they are not too busy paying politicians to write it, and by the risk-free income they receive due to government intervention. Having their cake and eating it too.
TL;DR: People is sick of bankers being given huge subsidies and removal of any risks by the government and watching them walk away with all the massive bonuses while the government saves them over and over.
How dumb is Stanley Fisher. Get a load of this quote:
ReplyDelete"All the emergency liquidity facilities that the Federal Reserve instituted were closed down and did not cost the taxpayers of this great country a single dime. Indeed, last year, as we finished up this work, the Federal Reserve paid $47.4 billion in profits to the Treasury. Imagine that! A government agency that (a) created programs that actually worked as promised, (b) made money for the taxpayers in the process and (c) undid the programs – all in the space of about 28 months – once they had done their job."
http://blogs.reuters.com/macroscope/2013/02/20/the-fallacy-of-fed-profits-and-losses/
Made money for the taxpayers???? All they did is return to TSY its own interest payments or interest payments that they are taxing away from the private sector via mortgage payments and into Fed pockets as MBS interest.
Actually worked as promised???? QE has done nothing for the real economy, all it has done is increase financial assets values back up to some natural higher level that occurs when TSY CDs arent offered. Interest rates even went up during QE due to ignorant expectations of inflation and output expectations.
Ended the programs???? They are still buying new securities when the ones they hold mature and will be doing so for years and years to come.
And this is a guy on the BOG????? IS it any wonder that Fed macro policy and thinking is so terrible, this guy is so incompetent and ignorant its fucking unfuckbelievable.
Great comment on the deferred asset to offset losses by Kervick. In case anyone thought government central banks were anything like users of currencies, once again, we are reminded that they are not. That could be an article unto itself as it is frequently held out as a reason for central banks around the world to act, their fear of losses.
ReplyDeletewhoa, I'm confused now. How can the fed run out of money? I thought one of the cool things about being the fed is you get to conjure money (reserves specifically) out of thin air. Isn't that how they bought the mbs's and tsy's during QE? Anyone have any good links on how this stuff works?
ReplyDeleteJoe read my wiki link in the first comment of the thread on Financial Factoring, that is what they are doing.
ReplyDeleteTheir H.4.1 Report is titled "Factors Affecting Reserve Balances" .... this is their report that people commonly mistakenly refer to as 'the Fed's balance sheet!".. its NOT a balance sheet it is a schedule of their factors....
http://www.federalreserve.gov/releases/h41/Current/
This was set up when we were under the gold standard and they are still doing the same things today....
from the wiki:
"The factor's overall profit is the difference between the price it paid for the invoice and the money received from the debtor, "
This is how the Fed "makes munnie" like genius Fisher is bragging about in Auburn's quote...
They think they are running a hedge fund for the taxpayers...
Ignacio if that is true then why would Wray bring up the whole "$29 Trillion" thing?
ReplyDeleteWhy bring in quantity at all?
You are projecting something not in evidence onto those people....
Dan Zero Hedge is not a right wing thing... it is very libertarian they cross post Washingtons Blog all the time same for Naked Capitalism... they are left libertarians at best... anti "surveillance" etc..
For all of those people to not be hypocrites they would have to jump on the "bankruptcy" bandwagon.... and I think they would...
Dan why wouldnt they just let the portfolio then run off right now? Instead of raising rates first?
ReplyDeleteWhy?
They did the QE lastly so why not let that part run off firstly?
Why?
This is why from their statement from just Weds:
"The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee's holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions."
So to say that they are planning to let the portfolio run off soon is just not reflective of what these people are saying.... they are currently planning to raise the rate well before any actions on the portfolio size... as they need the munnie....
Matt, I didn't say they are saying they are going to let the portfolio run off soon. They will change their asset purchasing policy when they decide to raise rates.
ReplyDeleteI always thought that Zero Hedge inclines toward the libertarian, Austrian and Ron Paul direction in economic policy. That's the right as far as I am concerned.