The Federal Reserve: Fool Me Once, Shame On You …

On Jan. 6 the Fed released a very important document, albeit one with a boring headline: "Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks."

Lulling the readers into a comatose state, the first sentence says that the release "has been modified to reflect an accounting policy change that will result in a more transparent presentation (emphasis added) of each Federal Reserve Bank's capital accounts and distribution of residual earnings to the U.S. Treasury."

More transparent? Who are they kidding?

Reading the documents a few times, here is my translation of the accounting change: If and when the Federal Reserve should lose money on the $2 trillion plus of securities on its balance sheets so as to erase its capital, the central bank does not have to record the loss.

From now on, the Fed allows itself to debit the loss to a liability account called "Interest on Federal Reserve Notes Due to the U.S. Treasury." Never mind if the Fed's capital of $52 billion has been wiped out. This novel accounting fiction ensures that the daily surplus capital of the Federal Reserve Bank remains as paid in capital, thus complying with the statutory mandate of the Federal Reserve Act.

Reuven Brenner holds the Repap Chair at McGill's' Desautels Faculty of Management.

Read full article: Forbes, January 28, 2011