Home / Rearranging the deck chairs on the Titanic economy  

Economics is typically considered very dry and of little interest to most. But to paraphrase the adage typically referring to politics, just because you ignore economics doesn't mean that it will ignore you. When it comes to evil-doers, they don't get much worse than the Federal Reserve, a private institution that makes its own rules, prints its own money, and is accountable to no one. The central bank is the gatekeeper of what economists can and cannot say, which is why only those outside the Fed's grip correctly predicted the economic collapse (ignoring for a moment faux economist Paul Krugman who claims he predicted the housing bubble collapse after advocating for the policies that led to it). But as the deck chairs are rearranged on the Titanic economy, the Fed has created a new, little-noticed rule that trillions of worthless assets should be held on the US government's balance sheet. Isn't that neat? With the stroke of a pen, you take all of your losses and move them completely to another party. Imagine going to gamble, incurring enormous losses, and then passing those losses off to the guy standing next to you at the craps table. How do you predict this story will end?


Concerns that the Federal Reserve could suffer losses on its massive bond holdings may have driven the central bank to adopt a little-noticed accounting change with huge implications: it makes insolvency much less likely.

The significant shift was tucked quietly into the Fed's weekly report on its balance sheet and phrased in such technical terms that it was not even reported by financial media when originally announced on Jan. 6.

But the new rules have slowly begun to catch the attention of market analysts. Many are at once surprised that the Fed can set its own guidelines, and also relieved that the remote but dangerous possibility that the world's most powerful central bank might need to ask the U.S. Treasury or its member banks for money is now more likely to be averted.

"Could the Fed go broke? The answer to this question was 'Yes,' but is now 'No,'" said 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.

Accounting Tweak Could Save Fed From Losses


Original posting by Braincrave Second Life staff on Jan 27, 2011 at http://www.braincrave.com/viewblog.php?id=449

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