Federal Reserve Bank “Magic Profits” Exaggerates US
by the Curmudgeon with Victor Sperandeo
Can a US corporation buy government bonds and mortgage securities with money created “out of thin air?” And then report the interest on those bonds as corporate income? Certainly not, but Federal Reserve banks do this all the time. Did you know that their so called "profits" – largely derived from interest on those same bonds – are included in total US corporate profits?
We only learned of this last week, but it’s been going on for many years. Huge increases in Fed bank profits account for a major portion of corporate profits (see Analysis section below). It was singularly responsible for ending the “profits recession” (which really hasn’t ended).
Why hasn’t the main stream media/financial press reported this trickery? What's happened to investigative financial journalism and reporting? After reading this blog post, could someone please ask NY Times financial editor Gretchen Morgenson.
Several years ago, the Curmudgeon wrote an article which asked if the Fed was a no risk hedge fund or a Ponzi scheme. We concluded it was both. The Ponzi scheme is based on the fact that US government issued debt (to fund its budget deficit) was being purchased by the Fed (a quasi-government agency) with money created “out of thin air” during rounds of QE and Operation Twist. In other words, the Fed was largely financing the US budget deficit with “monopoly money1.”
Note 1. The Federal Reserve pays for the bonds it buys by artificially creating reserve balances held by the banking system. It's an electronic “book entry.” The banking system must hold the quantity of reserve balances that the Federal Reserve creates until the purchased securities are sold (which hasn’t happened yet). The Fed’s balance sheet (assets-liabilities) has remained a tad over $4.5T since December 17, 2014.
Analysis - BEA Includes Fed Bank Interest Income as Corporate Profits:
The Ponzi scheme has been taken one step further by the US Bureau of Economic Analysis (BEA), which includes Fed bank earnings (i.e. risk free interest income on its $4.5+ balance sheet) as corporate profits. That makes the US economy appear to be much stronger than it actually is and has ended the “profits recession,” as noted in this post by Wolf Richter.
The BEA tracks “profits from current production” based on all US corporate entities. The BEA informs us of the components of corporate profits in Table 13.1—Content of Corporate Profits on its web site (emphasis added):
“These organizations consist of all entities required to file federal corporate tax returns, including mutual financial institutions and cooperatives subject to federal income tax; nonprofit organizations that primarily serve business; Federal Reserve banks; and federally sponsored credit agencies.”
The inclusion of Fed bank profits totally distorts the current corporate profits picture. For the Q1-2016, the Federal Reserve Banks reported a consolidated profit that had jumped 11% from a year earlier to a record $24.9 billion. No risk magic Fed profits (mostly from interest income) has been included in BEA’s measure of US corporate profits, which increased $8.1 billion in the 1st quarter.
Stéfane Marion, Chief Economist & Strategist at Economics and Strategy, National Bank of Canada, annualized the Fed’s profits to make them comparable to the BEA’s annualized corporate profits. Annualized, the Fed’s profit “surged $16.5 billion in Q1 – to a record $117.9 billion,” he wrote in a note. “Were it not for this increase, overall profits in the US would have actually been down for a third consecutive quarter,” Marion added.
On an annualized basis, the Fed’s “magic profits” accounted for 27.2% of US financial sector profits and for 5.3% of total US corporate profits (sharply rising blue line in the chart below), “the highest level in a generation.”
Marion summed up: “An improvement in corporate profits that is driven by the central bank is not a sign of a healthy economy.” What do you think?
It appears the BEA is actually justified in their inclusion of Fed Bank profits as corporate profits. The System of National Accounts, the international guidelines for GDP accounting, instructs countries’ statistical agencies to include central banks in the corporate financial sector. The Curmudgeon spoke to BEA’s Thomas Dail last Thursday who followed up with an email the next day:
“We follow these guidelines as closely as possible in part to make U.S. data comparable with other countries’ data. Here is the reference from the latest version (SNA 2008- pg. 76):
“As long as the central bank is a separate institutional unit, it is always allocated to the financial corporations sector even if it is primarily a non-market producer.”
By showing Federal Reserve Banks’ profits separately in our data (sent to Victor yesterday), we allow analysts to determine how the Federal Reserve Banks affect overall corporate profits and how corporate profits would look if they were excluded.”
The most recent BEA table of US corporate earnings is here. Note line 11. Federal Reserve banks. There you'll see that 1st Q-2016 profits were $117.9B. Compare that to 1st quarter 2014, when they were only $97.3B. That’s consistent with the two eye opening charts shown above.
Did you know that? Again, we ask why the main stream media/financial press hasn’t picked up on this chicanery?
The US Bureau of Economic Analysis (BEA) calculates corporate earnings, among many other US economic reports including GDP. As the Curmudgeon explains above, the BEA calculation of total corporate earnings includes the earnings of the 12 Federal Reserve Banks, under the logic that they are "private corporations."
For perspective, how profitable is the Fed? How does the Fed's profitability compare to America's other gigantic businesses? Joshua M Brown wrote about The Insanely Profitable Federal Reserve in a 2014 blog post:
"For starters, the $90 billion or so in total interest income the US central bank's portfolio paid out is equal to about one-third of all corporate dividends paid by US companies in 2013 ($311.8 billion).
The Federal Reserve, after operational costs, is earning double the profits of Exxon Mobil ($44 billion) and Apple ($41 billion), and those two companies are doing a combined $600 billion in global revenues! The Fed is in a much better business than finding oil or making phones - instead it merely sits atop a $4 trillion (today $4.5 trillion) portfolio of mostly risk-free bond investments and is the de facto ultimate decider of what the interest payments are going to be. Not bad work if you can get it."
Under the guise of helping the economy (without costs to anyone), the Fed bought US government and mortgage debt (under the arcane label of "QE") with money printed out of thin air! That increased its balance sheet to over $4.5 trillion. Interest on the purchased debt is paid to the Fed, which remits the proceeds (after subtracting expenses) to the US Treasury Dept. That “magic income” is then added to total earnings of all other corporations for the total compiled by BEA. That compares with the grand magic trick of making an "elephant “appear out of thin air!
Let's take it a step further with a hypothetical scenario. Suppose the Fed bought the other $14.8 trillion in US government debt outstanding. The interest on the total Fed debt would swell Fed bank profits such that US corporate earnings would grow by an estimated 330% - without any costs to anyone!!!
I hope you all see the impeccable logic of this form of accounting. It is legal fraud.
The same flawed logic applies to why "student loans” are not included as part of US government debt, as they are off budget. Why? I have no idea of the reason or excuse?
Housing also is not counted as spending or debt. However, the earnings from Fannie Mae and Freddie Mac are counted as US government income, which lowers the yearly budget deficit, but does not raise the debt?
Who Controls the Mainstream Media?
Why doesn't the general media (print/newspapers, Internet, TV, radio, etc.) report on this kind of clear deception, along with the Fed's lack of candor and transparency?
Perhaps, it is because the mainstream media is controlled by the puppet masters. Who are the "puppet masters"?
Let’s start with family dynasties, like John D. Rockefeller (net worth $340 billion), Rothschild (net worth $350) billion, and JP Morgan ($41 billion net worth). One assumes those families own part of the Fed, because they helped start it. But the actual Fed owners2 are never disclosed. Again, that’s a lack of transparency?
Note 2. The Curmudgeon has reported what’s public knowledge: The owners of the 12 regional Fed banks are local commercial banks (and other undisclosed entities) who get a 6% dividend per year on the Fed stock they own. But there is no information on what that dividend is based on, i.e. Fed bank net earnings for a given year, the Fed’s balance sheet, an assessment of the Fed’s net worth or “book value,” etc.
Dennis L. Cuddy, Ph.D. wrote on page 21 of his book "The Road to Socialism and the New World Order:”
"In March 1915 the JP Morgan "interests" ... got together 12 men high up in the newspaper world and employed them to select the most influential newspapers in the US and sufficient number of them to CONTROL generally the policy of the daily press.... These 12 men worked the problem out by selecting 179 newspapers...they found it was only necessary to purchase the control of 25 of the greatest papers."
The average salary (adjusted for inflation) was $16,063 in 1915. The net worth of the family dynasties allowed them to control anything they wished.
Could that CONTROL of the press and on-line/TV media still be the case today? If so, the press is under the thumb of those same wealthy families that helped create the Fed and is not free.
Many excuses, rationalizations, and outright lies are espoused to make people have faith in government. Elected officials want to make us all believe that they'll do the right thing for the people so that we should all vote for our favorite "political personalities."
The essence of why government tries to make people feel they will help them is to get the politicians who run the government elected or re-elected. With rare exceptions, this desire for government power is not to help the people, but rather it's a lust for power, control, and the money/wealth which follows it.
We have many times discussed the ways the US government attempts to fool the people and lie (or be silent) about reality when it is not pleasant or contradicts previously stated official positions. We haven't even talked about the military deception, like US troops supposedly no longer fighting the Taliban in Afghanistan. Really?
The more you look into government matters of any kind, the more corruption, deception, chicanery, double dealing, and charlatan tactics you will find. As John Perkins author of "The Confessions of an Economic Hit Man" wrote:
"This empire, unlike any other in the history of the
world, has been built primarily through economic manipulation, through
cheating, through fraud, through seducing people into our way of life, through
the economic hit men. I was very much a part of that."
Good luck and till next time...
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Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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