The Federal Reserve System Returns To Profitability

The Federal Reserve is on track to post its first systemwide profit since the fourth quarter of 2022. Since September, 2022, the combined expenses of the 12 Federal Reserve district banks and the Federal Reserve Board of Governors (BOG) have exceeded the system’s combined income. The Fed has accounted for these losses by accumulating balances in a unique account—“Earnings Remittances due the U.S. Treasury”. The Fed describes this “magic asset” as the cumulative amount of net earnings the system must generate and retain before it will resume paying remittances to the U.S. Treasury. On a combined basis, the balance in the magic asset account peaked during the week ending November 5, at $243,818 million and has declined slightly in subsequent weeks as the system eked-out positive net earnings.    

The Fed’s magic asset accounting is more complicated than the aforementioned explanation implies. From January 2021, Congress limited the Federal Reserve’s combined surplus account balances to $6.875 billion and empowered the BOG to allocate this surplus limit among the Fed’s 12 district banks. Remittances to the Treasury are calculated at the district bank level. After paying expenses, and its member banks’ their dividend, a district bank may retain earnings in its surplus account, provided the account balance does not exceed its BOG-allocated surplus limit. After topping up its surplus account, any remaining earnings must be remitted to the Treasury on a weekly basis.

What if a district bank has a shortfall after paying expenses and dividends to its member banks?  Any public company using GAAP accounting would reduce its retained earnings balance (the Fed’s surplus account) by the loss, and if its retained earnings balance was exhausted, reduce the balance in its paid-in equity account. 

Here is where the magic asset comes into play. The Fed sets its own accounting standards, and it decided that losses would not reduce its surplus or paid in capital balances, but would instead be accumulated in an account called “Earnings Remittances due the U.S. Treasury”. This account appears as a liability with a negative balance. If the district bank subsequently has earnings remaining after paying its expenses and dividends, it uses the excess earnings to reduce the negative balance in this account. The bank will not reduce its surplus or equity account balances and will not resume making remittance payments to the Treasury until the Earnings Remittances due the U.S. Treasury account has a zero balance.

As can be seen the chart above, on a combined basis the Fed has posted quarterly losses since 2022Q4 and yet because remittances are calculated at the district bank level, the Fed has continued to make remittance payments to the Treasury throughout this period because some district banks remained profitable. Indeed, because a large percentage of their funding comes from Federal Reserve Notes which do not pay interest, the Federal Reserve banks of Atlanta and St. Louis have remained profitable and have continued to remit their excess earnings to the Treasury even while 9 of the 10 remaining district banks were deeply insolvent on a GAAP basis (Dallas is the exception).

While 6 of 12 district banks have posted losses in at least one recent week (and several in multiple weeks), on a combined basis, the system as a whole has been profitable each week since November 12. According to my calculations based on Fed H.4.1 data through December 3, fourth quarter combined system profits (shown above) total $804 million while Treasury remittances from the Atlanta and St Louis district banks total $1,239 million. While week-to-week combined system profits can be volatile, with an anticipated additional FOMC rate cut on Dec 10, a combined fourth quarter Fed profit seems secure. While the Fed as a whole seeming has turned a corner back to profitability, not all district banks are reliably profitable. Moreover, at the current pace of earnings, it will take some time for the system to earn the $243,180 million (after expenses and dividends) needed to reduce the system’s magic asset balance to zero.