econintersect.com
       
  

FREE NEWSLETTER: Econintersect sends a nightly newsletter highlighting news events of the day, and providing a summary of new articles posted on the website. Econintersect will not sell or pass your email address to others per our privacy policy. You can cancel this subscription at any time by selecting the unsubscribing link in the footer of each email.



posted on 12 August 2017

A Closer Look At The Fed's Balance Sheet Accounting

from Liberty Street Economics

-- this post authored by Deborah Leonard, Antoine Martin, and Jennifer Wolgemuth

An earlier post on how the Fed changes the size of its balance sheetprompted several questions from readers about the Federal Reserve’s accounting of asset purchases and the payment of principal by the Treasury on Treasury securities owned by the Fed. In this post, we provide a more detailed explanation of the accounting rules that govern these transactions.

Overview of the Federal Reserve System

It is useful to start with an overview of the Federal Reserve System. The System is decentralized and consists of three key entities: (1) The Board of Governors of the Federal Reserve System (the Fed’s central governing board); (2) twelve Federal Reserve Banks (through which the System operates); and (3) the Federal Open Market Committee (the FOMC, which sets U.S. monetary policy and consists of members of the Board of Governors and some Reserve Bank presidents).

As the operating arms of the System, the Reserve Banks hold the System’s assets, liabilities, and capital. Accordingly, the Federal Reserve’s balance sheet actually represents the accounts and results of operations of the Reserve Banks - their combined and individual statements of condition are reported weekly in tables 5 and 6 in the H.4.1 statistical release and in annual audited financial statements of the Federal Reserve System.

Federal Reserve Purchases of Treasury Securities

Reserve Banks are authorized to purchase Treasury securities in the open market (the secondary market) under the terms of Section 14 of the Federal Reserve Act and at the direction of the FOMC. The FOMC has selected the Federal Reserve Bank of New York to execute open market operations. The securities acquired are then allocated across the Reserve Banks.

When a Reserve Bank purchases a Treasury security, it purchases an asset, typically from a bank or broker-dealer. It credits reserves (a liability of the Fed) to the reserve account of the seller (or the seller’s bank). The bank or broker-dealer may sell its own securities or may act as an agent on behalf of a client. As a holder of a Treasury security, a Reserve Bank has no special rights relative to other Treasury-holding entities. The Treasury security that the Fed has purchased is not “paid in full." It remains an asset on the Fed’s balance sheet until the security matures or is redeemed by the Treasury in accordance with the terms of issuance.

The Relationship between the Fed and the Treasury

As the nation’s central bank, the Fed plays a number of important public policy roles, and monetary policy does indeed have fiscal implications. In trying to understand the effects of the Fed’s actions on public finances and debt, it can be convenient, in some cases, to think about a consolidated public sector balance sheet that sums together the respective assets and liabilities held by the Fed and the federal government. Nevertheless, as noted in an answer to a comment on our earlier post, the Federal Reserve Banks are independent entities, with their own balance sheets, separate from that of the Treasury. There is no authority to consolidate Reserve Bank and Treasury balance sheets.

One might wonder whether the Fed could coordinate with the Treasury and agree to an accounting offset, so that every time the Fed buys a Treasury security, the security is considered “paid in full." In fact, neither the Board of Governors nor any Reserve Bank is authorized under the Federal Reserve Act to fund the repayment or retirement of a Treasury security; only the Treasury can do so, and it can do so only under the terms under which it issued the security.

Even if it could coordinate with the Treasury and agree to an accounting offset every time it buys a Treasury security, the Fed may prefer to hold on to these assets for future use. Indeed, just like any other entity with Treasury holdings, a Reserve Bank may resell or lend Treasury securities - as the New York Fed does - subject to the Section 14 open market limitation and FOMC directions. But again, a Reserve Bank does not have the authority to fund the payment or retirement of Treasury securities, which are obligations of the U.S. government.

What Happens When a Treasury Security on the Fed’s Balance Sheet Matures?

As discussed in the previous post, when a Treasury security on the Fed’s balance sheet comes due, the Fed can roll over the security or let it mature. A rollover is used if the Fed wants to keep the amount of Treasury securities it holds constant. Reserve Banks do not have the authority to purchase securities directly from the Treasury Department, but they may exchange maturing securities for newly issued securities (so that, on net, no new money is paid to the Treasury). This is how things are done under the current rollover program.

What if the Fed lets the security mature? As is standard in accounting, the payment of principal is not recorded as income (although the payment of interest is). When a Treasury security is paid off, the payment from the Treasury’s General Account at the Fed simply offsets the value of the maturing Treasury security. If the Treasury security was held by an individual, then a new asset - cash - would replace the old asset - the Treasury security - on the asset side of the individual’s balance sheet. This replacement of one asset by another does not represent income.

In the case of the Fed, things are slightly different because a Fed liability, balances in the Treasury General Account, is used to pay off the Treasury security; as a result, both the asset and the liability sides of the Fed’s balance sheet decrease. But, for the same reason stated above, this does not constitute income.

To Sum Up

The way the Fed accounts for changes to its balance sheet depends in part on the structure of the Federal Reserve System and the fact that the Fed is not part of the Treasury. In this post, we have tried to provide more detail on the accounting rules governing transactions that can affect the size of the Fed’s balance sheet.

Disclaimer

The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

Source

http://libertystreeteconomics.newyorkfed.org/2017/08/a-closer-look-at-the-feds-balance-sheet-accounting.html


About the Authors

Deborah Leonard is a vice president in the Federal Reserve Bank of New York’s Markets Group.

Martin_antoineAntoine Martin is a senior vice president in the Bank’s Research and Statistics Group.

Jennifer_WolgemuthJennifer Wolgemuth is a vice president in the Bank’s Legal Group.

>>>>> Scroll down to view and make comments <<<<<<

Click here for Historical News Post Listing










Make a Comment

Econintersect wants your comments, data and opinion on the articles posted. You can also comment using Facebook directly using he comment block below.




Econintersect Contributors








search_box
Print this page or create a PDF file of this page
Print Friendly and PDF


The growing use of ad blocking software is creating a shortfall in covering our fixed expenses. Please consider a donation to Econintersect to allow continuing output of quality and balanced financial and economic news and analysis.







Keep up with economic news using our dynamic economic newspapers with the largest international coverage on the internet
Asia / Pacific
Europe
Middle East / Africa
Americas
USA Government





























 navigate econintersect.com

Blogs

Analysis Blog
News Blog
Investing Blog
Opinion Blog
Precious Metals Blog
Markets Blog
Video of the Day
Weather

Newspapers

Asia / Pacific
Europe
Middle East / Africa
Americas
USA Government
     

RSS Feeds / Social Media

Combined Econintersect Feed
Google+
Facebook
Twitter
Digg

Free Newsletter

Marketplace - Books & More

Economic Forecast

Content Contribution

Contact

About

  Top Economics Site

Investing.com Contributor TalkMarkets Contributor Finance Blogs Free PageRank Checker Active Search Results Google+

This Web Page by Steven Hansen ---- Copyright 2010 - 2017 Econintersect LLC - all rights reserved