It seems the news that Congress “raided” the Fed surplus account, or at least that is the description of the act by Congress in the latest highway bill in this Washington Post editorial, gets around fast. Never mind corruption cover-ups, sinking NDGP and inflation expectations a midst unjustified rate rise chatter, the People’s House simply cannot destroy the integrity of the Fed by leaving it subject to loss to pay for roads.

Instead, the six-year bill cobbles together financing from expedients: one-time strategic petroleum sales; ostensibly improved tax compliance; and, most dubiously, a raid on the Federal Reserve’s capital. The Fed returns the vast majority of earnings on its portfolio (swollen by recession-fighting expansive monetary policy) to the treasury. But it retains some each year, matched by payments from banks, as a buffer against losses. The practice strengthens the Federal Reserve’s balance sheet and thus increases public confidence in its ability to weather a crisis, albeit marginally. It is part of what makes the Fed a credible, independent central bank.

This sounds a lot like the Marvin Goodfriend paper I referenced in my last post, with some nuanced differences.

Furthermore, according to GAO (2002), Federal Reserve Board officials noted:

…it can be argued that a central bank, including the Federal Reserve System, may not need to hold capital to absorb losses, mainly because a central bank can create additional domestic currency to meet any obligation denominated in that currency. Federal Reserve Board officials acknowledged that determining the appropriate level of a central bank’s capital account is difficult…[GAO (2002), page 7]

Currently, the Fed pays its excess interest earnings to the Treasury weekly. Starting from zero, the Fed accrues payments each week as so-called undistributed net income which it remits to the Treasury with a week lag. As an accounting matter, undistributed net income has not been allowed to go negative. For example, whenever a revaluation of foreign security holdings or a realized loss on the domestic portfolio causes it to do so, assets have been moved from the surplus account to bring undistributed net income back up to zero. In the following weeks, no transfers are made to the Treasury until the Fed’s assets are replenished and surplus is restored to the level of paid-in capital.

Surplus, then, serves as a buffer helping to protect paid-in capital and to insure that the Fed’s securities cover its liabilities. Eliminating even the entire Fed paid-in capital and surplus, which currently stands at around $50 billion would reduce the Fed’s portfolio of securities by far less than one-tenth of 1%, so it would certainly not impair the Fed’s ability to conduct policy. The elimination of surplus, however, would undermine the principle that the Fed should retain possession of the interest earning assets it acquires through the creation of bank reserves and currency.

It seems as if the anti-democrats enamored with the idea of unelected bureaucrats tyrannizing the money supply conveniently include the Fed and its assets under the governmental banner when the Fed is required to exercise power to destroy, but certainly not when it comes for paying for things of public benefit. After all, we could just pile more financial burden on top of commuters than the Fed has already done with a policy regime biased toward tight by increasing the gasoline tax so that Fed bureaucrats won’t have their ivory tower disturbed by mere halfwits and zeroes who have been elected by THOSE people.

It is, perhaps to those anti-democrats, worth the cost to maintain an independent central bank, though the evidence to support whatever tradeoff that might entail is lacking in detail. Certainly they do not intend to lead us, people who can think for themselves, to unsupported conclusions. Really, where do they believe a deflationary crisis that would threaten the solvency of the Fed would come from? Perhaps the Fed has just too many incentives toward a tight bias and removing a few of those is the more practical idea.

It really is sad that the frontal assault on the Fed by the Senate Banking Committee earlier this year, the effort to apply policy accountability, failed. In the absence of that, however, at least Congress has found a way to impose penalties that in effect diminish the Fed’s unbridled and unreformed exercise of power of moral authority, however slightly. Money=power and removing excess funds from the offending bureaucracy is small a start.

Three cheers for Congress. But it has much more to do to even the score between “The People” and the Fed.  I am looking forward to it with a huge tub of popcorn in hand.