'Let's Pretend' Headline via Reuters: 'Accounting Tweak Could Save Fed From Losses'

Trick? Or "tweak"?

On Friday, a Reuters report at CNBC noted the Federal Reserve's journey into the accounting and reporting twilight zone earlier this month. In doing so, it conducted a clinic in how to make unreality look acceptable and make a dangerous situation appear palatable.

In the el bizzarro world at Reuters and those the wire service interviewed for its article:

  • A change in how one accounts for things can magically make a functionally insolvent entity solvent again.
  • Such a change can also mean that an entity which has run out of cash and has to beg for funds no longer has to.
  • Calling a genuine erosion of capital something other than an erosion of capital means that it's no longer an erosion of capital.

Gee, why didn't they just do this at Fannie Mae, Freddie Mac, and Lehman Brothers 2-1/2 years ago and let things go on as usual?

Here's most of the Reuters report (bolds supporting the bullet points above are mine):

Concerns that the Federal Reserve could suffer losses on its massive bond holdings may have driven the central bank to adopt a little-noticed accounting change with huge implications: it makes insolvency much less likely.


The significant shift [1] was tucked quietly into the Fed's weekly report on its balance sheet and phrased in such technical terms that it was not even reported by financial media when originally announced on Jan. 6.


But the new rules have slowly begun to catch the attention of market analysts. Many are at once surprised that the Fed can set its own guidelines, [2] and also relieved that the remote but dangerous possibility that the world's most powerful central bank might need to ask the U.S. Treasury or its member banks for money is now more likely to be averted.


"Could the Fed go broke? The answer to this question was 'Yes,' but is now 'No,'" said Raymond Stone, managing director at Stone & McCarthy in Princeton, New Jersey. "An accounting methodology change at the central bank will allow the Fed to incur losses, even substantial losses, without eroding its capital." [3]


The change essentially allows the Fed to denote losses by the various regional reserve banks that make up the Fed system as a liability to the Treasury rather than a hit to its capital. [3] It would then simply direct future profits from Fed operations toward that liability.


This enhances transparency [4] by providing clearer, more frequent, snapshots of the central bank's finances, analysts say. The bonus: the number can now turn negative without affecting the central bank's underlying financial condition. [5]


"Any future losses the Fed may incur will now show up as a negative liability as opposed to a reduction in Fed capital, thereby making a negative capital situation technically impossible," [3] said Brian Smedley, a rates strategist at Bank of America-Merrill Lynch and a former New York Fed staffer.

Other notes:

  • [1] -- When does an "accounting tweak" turn into a "significant shift"? It seems that the answer is: "When you're no longer worried about  writing a deceptive headline."
  • [2] -- When a hardened leftist is in the White House and the central bank is trying to save his administration from the consequences of its historically unprecedented profligacy, silly things like "guidelines" don't matter.
  • [3] -- In all three instances cited the correct term is not "capital," it's "reported capital." What's really happening is that the accounting change involved enables the Fed to tell financial statement readers that it has more capital than it actually does.
  • [4] -- You know you've entered the twilight zone when an accounting maneuver designed to cover up losses is tagged as a transparency enhancement.
  • [5] -- This is where entering the accounting and reporting twilight zone ultimately takes you. In the real world, all the numbers-manipulating exercises in the world can't change an entity's "underlying financial condition."

Such accounting trickery wouldn't work, even in the short term, unless it were presented favorably by an establishment press desperately trying to keep the economy from hitting a wall while its favored president is in the White House. It's not at all unreasonable to believe that if the Fed had done this while George Bush was still around, it would have been treated as accounting chicanery of epic proportions -- which is what it really is.

It would appear that the Fed is one serious spike in interest rates away from becoming the newest member of the "Progressive Hall of Shame." Current members include Social Social Security, Medicare, Fannie Mae, and Freddie Mac -- all government monsters which, having been allowed to grow far beyond their original charters, subsequently became "too big to fail." The fact is that all of them have failed. They may soon have to make room for the country's central bank.

Cross-posted at BizzyBlog.com.

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