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In normal years, i.e. prior to the crisis, the Fed buys and sells government bonds (i.e. government debt) almost exclusively and typically earned around $18 billion per year. The Fed takes all of its operating and other expenses out of this, and at the end of the year anything left over is returned to the Treasury and taxpayers.
As the following graph shows, the amount the Fed earns each year has been rising since the onset of the crisis, and yesterday it was announced that the Fed earned a record $45 billion in 2009 (these are net of operating expenses, i.e. an estimate of what the Fed will turn over to the Treasury).
Why were the earnings so much higher than usual? There are two reasons. First, the quantity of bonds the Fed purchased increased significantly, so part of it is simply a volume effect. Second, the mix of assets changed as the Fed used the TARP program to take risky (toxic) assets off of bank balance sheets, i.e. the Fed began buying private sector bonds in addition to its usual purchase of government bonds, and some of those assets appreciated significantly.
Felix Salmon at Reuters
notes that if the earnings were paid out to Fed employees, they would do quite well:
Essentially all that $45 billion was earned by one profit center, the New York Fed… Let’s be conservative and call it $21 billion. The New York Fed has 3,000 employees, which means that the bonus pool would work out at $7 million per employee: a full order of magnitude greater than the equivalent number at Goldman Sachs.
However, as Felix observes, perhaps the payments aren’t fully justified since it doesn’t take a lot of skill to make money if you are allowed to print it. If I could print money, buy government bonds, and then keep the interest payments, I could make money too (though the toxic asset component of the purchases was a bit more risky). Ezra Klein
says:
“the Fed’s earnings for the year will dwarf those of the large banks, easily topping the expected profits of Bank of America, Goldman Sachs and J.P. Morgan Chase combined.” The money here is mostly coming from an aggressive policy of buying bonds to lower interest rates, and given that the Federal Reserve can get money for nothing, the yield on those bonds is pretty much pure profit.
That money is going straight back to the rest of the government, which makes sense. On the other hand, I can’t help but wish the Federal Reserve would take a quick lesson from Wall Street and hand out some fat bonuses, or maybe some serious raises. It wouldn’t be the worst thing in the world if some of the bright young things who flood into investment banks each year thought hard about going into central banking instead — particularly if we’re really going to expand the Federal Reserve’s power and make it into a much more aggressive regulator.
That’s a good point. If we don’t pay regulators their opportunity cost, i.e. if we don’t pay them what they could earn in the private sector, then few will choose to work for the government and the balance of talents will not be equal. If the Fed wants to match private sector talent, it has to be willing to pay for it.
In any case, that the Fed is earning more than expected is good news. They will likely still end up with net losses once all is said and done since the bailouts of automakers, Fannie, and Freddie are likely to end up in the red, and it may be holding securities that have lost value, but those losses won’t be nearly as large as some expected.
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