EVER since the Federal Reserve first started buying up financial assets back in 2008, some have fretted about taxpayer exposure. The private debt purchased by the Fed to prop up the financial system might sour. The government bonds it has bought with newly created money, a strategy dubbed “quantitative easing” (QE), could fall in value if interest rates rose.
The reality has been happier. The Fed’s assets have ballooned to nearly $3 trillion, mostly in Treasuries and mortgage-backed securities (MBS). It paid $89 billion in profit to the Treasury for 2012, the largest in a string of record-breaking remittances (see chart). Before the crisis, the Fed’s profits were typically only a third of that.
The Fed makes its money much as most banks do: from the spread between the return on its assets and the interest paid on its liabilities. The Fed’s liabilities are principally made up of currency in circulation, which pays no interest, and reserves, the cash that commercial banks keep on deposit at the Fed. Since 2008 these reserves have exploded to $1.6 trillion, on which the central bank pays only 0.25% interest. The difference between that modest cost and the average return of about 3.5% on its bond holdings explains the whopping “seigniorage”, as the profit the Fed earns from printing money is called.
Some Fed officials worry about what comes next. When the Fed raised rates in the past, it meant little for profits because reserves were trivial and earned no interest. Since 2008 the Fed has paid interest on reserves in order to maintain control of interest rates. So when the Fed eventually tightens monetary policy, it will have to pay out more interest. To absorb reserves it may have to sell some bonds for less than what it paid, incurring capital losses. In theory, it could end up losing money, a risk that grows the more bonds it buys.