4. The Federal Reserve Bank of New York has grown dramatically in the last decade. From 2004 to 2014, the total assets reported by the FRBNY grew from $364 billion to $2.7 trillion – a seven-fold increase. In banking, rapid growth can be a sign of risk, and the FRBNY has been one of the fastest growing banks in the nation.
The Fed’s response to the financial crisis in 2007-2009 explains why the FRBNY has been growing so rapidly. The Fed conducts “open market operations” to implement monetary policy. These operations involve buying and/or selling massive amounts of securities. When the Fed buys securities, it does so by crediting accounts for the dealers from whom they purchase the securities, leading to a higher “money supply,” and higher prices and lower interest rates for the securities they purchase.
The Fed drove short-term rates down to near-zero levels in 2009, and stated that it would continue to try to stimulate the economy through a “quantitative easing” policy. This involves buying securities in large volume, and the Fed also began buying mortgage-backed securities in addition to Treasury bonds.
As longer-term interest rates have been falling in recent years, bond prices have been rising. That isn’t necessarily what will happen in next few years, however. The Federal Reserve banks are open to interest rate risk, like any bank, and rising longer-term interest rates could bring significant losses to the FRBNY’s bond portfolio.
Former Federal Reserve economist Marvin Goodfriend has called the Fed’s policy a “bond market carry trade,” and has urged the Fed to retain more of its earnings to build surplus capital and prepare for the day when it must pay higher interest rates on bank reserves. Greater capital would work to cushion the Reserve Banks against possible future losses on their bond portfolios. Goodfriend has expressed concern that the Fed has continued to remit most of its earnings to the U.S. Treasury, as opposed to building up its capital account.
5. The Federal Reserve Bank of New York is apparently very thinly capitalized. The FRBNY reported $18.4 billion in total capital in 2014. This may sound like a lot of money, but it pales in comparison to $2.7 trillion in total assets.
Back in 2004, the FRBNY reported $6.9 billion in capital against $364 billion in assets, or with assets/capital running at 53:1. By 2014, that ratio had risen to about 150:1.
A slim loss in the asset base could theoretically wipe out all the equity.
If interest rates begin increasing, FRBNY earnings are exposed to risk on at least two fronts. First, under new monetary policy procedures, the Reserve Banks are paying interest on reserves that banks maintain at the Fed. Second, rising interest rates on longer-term maturities would lead to losses on bonds in the FRBNY portfolio.
Losses can be real, economic losses, but that doesn’t mean they show up in accounting statements. A few years ago, the Federal Reserve changed the accounting standards it sets for itself in a way that would shield its capital account from being impaired, at least on the books it prepares for the public.
6. The Federal Reserve makes its own accounting standards. The Federal Reserve Banks may be banks, but they don’t follow the same accounting standards that banks do. The Federal Reserve Board of Governors creates the accounting standards for the Reserve Banks, which reside in the “Financial Accounting Manual.”
The Fed has argued that its independence needs to be protected, with the power to set its own accounting standards a key element in that independence. Others disagree, and some have argued that the Fed has used this authority to obfuscate reality and mask the risk it undertakes, with implications for the U.S. Treasury and federal taxpayers.