The Federal Reserve Loses Money On Every Investment, Will Have To Make It Up On Volume

The Federal Reserve issued the first installment of what it calls its ongoing series of monthly reports that provides new information on its credit and liquidity programs. Most of the June report was dry, but two things stood out. The first was the extent to which the Fed balance sheet is made up of junk, paper that is rated BB+ or lower. The second and more obvious fact was that the agency wrote-down $5.25 billion in the first quarter.  Most of the losses came from a re-valuation of securities acquired as part of the restructurings of Bear Stearns and AIG. The agency has some income to offset the red ink. According to the AP, “The Fed reported $4.57 billion in earnings under its regular transactions involving Treasury securities.”

The silver lining in the Fed’s report is the nature of the securities it has taken onto its balance sheet in order to keep the credit and financial system intact.  The Fed hopes that the value of the paper will recover over many years and the junk taken in as distressed securities will eventually turn into gold.

Some members of Congress were upset that the agency refused to give out the names of financial firms which got emergency funds from the Fed. Chairman Bernanke’s excuse for the secrecy is a good one. Any institution taking money from the agency outside the normal course of business would immediately become a financial pariah. Its ability to keep customers and carry on transactions with other institutions would be ruined. The Fed would be faced with the prospect of another Bear Stearns or Lehman Brothers debacle, all in the name of transparency.

Bernanke will not come out and say it, but transparency is overrated, particularly in times of emergency. Military people rarely give out maps of places they plan to attack or areas where they have too few assets to defend. It would be like playing poker in front of a mirror.

Members of Congress, particularly the well-tailored Christopher Dodd, want the name of every institution that has taken a dime from the Fed. It has been mentioned so often that he may have spent too much time in the Connecticut sun.

The Fed’s habit of discretion has already gotten it into some trouble with Congress. The agency was forced to release documents about how the Fed and the Treasury convinced Bank of America (BAC) CEO Ken Lewis to agree to the disastrous transaction in which his company finally bought Merrill Lynch. Mr. Bernanke who has the appearance of a 98-lb weakling turns out to have cuffed Lewis around until the weaker man agreed to buy the brokerage firm, even though it was clearly not in the best interest of B of A shareholders.

Bernanke will need to defend his philosophy of secrecy over and over again.  Otherwise, the financial world will face a flood of bad news that would make the panic last fall look like a day in Dodd’s sunny state.

Douglas A. McIntyre