The Bipartisan Budget Act passed last week had a little item in it to help government revenues by confiscating $2.5 billion of the retained earnings (they call it “surplus”) of the Federal Reserve Banks.  When they found out about it, the commercial banks, which own all the stock of the Federal Reserve Banks, weren’t happy.

“Critics say the plan is yet another example of Congress turning to the Fed as a source of funding,” the American Banker reported.  It is now “common to use the Fed as a piggy bank,” complained the Independent Community Bankers association.

The Fed as a piggy bank?  Of course, what else?  According to the Federal Reserve’s own press release, the Federal Reserve Banks paid $80.2 billion of their 2017 profits to the Treasury.  In other words, 99 percent of their estimated net profit for the year of $80.7 billion goes to the government to help reduce the budget deficit.  To confiscate another $2.5 billion only increases the aggregate take by 3 percent.

The Federal Reserve Banks have the highest rate of profitability of any bank, with a 2017 return on equity of about 195 percent.  Of course, they are also astronomically leveraged, with assets of about 107 times equity, or a tiny capital ratio of a 0.9 percent.  Almost all of that leveraged profitability goes right into the Treasury, every year.

The Federal Reserve Banks paid aggregate dividends to their shareholders of $784 million in 2017, or less than 1 percent of what they paid the government, which is a greedy business partner, it seems.

The Federal Reserve System is many things, but one of them is a way for the government to make a lot of money from the seignorage arising from its currency monopoly.  The Fed creates money to buy bonds from the Treasury, collects the interest, then gives most of the interest back.  It also uses its money power to buy mortgage-backed securities from Fannie Mae and Freddie Mac, which are owned principally by the Treasury, collects the interest on them, and then sends most of it to the Treasury.

As my friend and banking expert Bert Ely always reminds me, it is easier to understand what is going on if you simply consider the Treasury and the Fed as one interacting financial operation, and consolidate their financial statements into one set of books, clarified by consolidating eliminations.  Then you can see that on a net basis, the consolidated government is creating money instead of borrowing from the public in order to finance its deficits and in order to generate vast seigniorage profits for itself.  The Fed makes a very useful front man for the Treasury in this respect.

The first congressional confiscation of Federal Reserve retained earnings was in 1933.  Then they were taken to provide the capital for the newly formed Federal Deposit Insurance fund.  So as usual in financial history, taking the Fed’s retained earnings is not a new idea.  The Federal Reserve Banks are a politically useful piggy bank, to be sure.

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