The Federal Reserve’s Accounting for Its Own Losses Is Emerging as an Embarrassment That Only Congress Can Fix

A basic principle of accounting is that net operating losses are subtracted from retained earnings and thus from capital. If the losses are big enough, capital goes negative, your liabilities exceed your assets, and you are technically insolvent. The Federal Reserve requires all the banks it regulates to follow this principle.Remarkably, though, the Federal Reserve proclaims itself exempted from this basic — and obvious — arithmetic. Exempted by whom? By itself. This is an embarrassment. It is also a conflict of interest and a temptation for a money-losing entity to have control of its own accounting rules.The losses of the Federal Reserve since they started in 2022 are so big — $226 billion so far — that they have wiped out all the central bank’s retained earnings, which it calls “surplus,” and all its paid-in capital, five times over. Here is what the simple arithmetic adds up to:The Federal Reserve’s accumulated losses are $226 billion. Retained earnings (“surplus”) are 7 billion. Subtract that to get retained earnings of negative $219 billion. Subtract paid in capital of $37 billion. That leaves actual capital of negative $182 billion. It’s simple and straightforward. It means that the United States Federal Reserve has lost all its retained earnings and all the capital that its stockholders — private commercial banks — invested in it, and then lost $182 billion more. Nonetheless, the Fed publishes a balance sheet that shows positive capital of $44 billion.How can that be? Well, it’s a great thing, if you are losing an ocean of money, to set your own accounting rules so you can avoid the effect of the losses on your capital. To do that, the Federal Reserve books its losses as an asset. It manages to keep a straight face with central banking dignity while it explains that its losses are a so-called “deferred asset.”Most newspapers dutifully repeat this, but anyone who passed Accounting 101 knows that it’s nonsense. In accounting terms, the losses are a $226 billion debit which should go to reduce retained earnings, but instead is hiding out in a more than dubious asset account.You may wonder how this can happen when the Fed’s balance sheet is audited by an independent accountant (currently KPMG). As the auditors make clear every year, they do not examine the Fed’s books according to Generally Accepted Accounting Principles, but instead follow rules devised by the Fed.To our particular point, they follow the “deferred asset” rule the Fed made up for itself in 2011 when it realized it might have unprecedented losses and wished to obscure their effect. It has turned out that the losses and the obscuring are far greater than the Federal Reserve expected and continue to get bigger every month. Fed representatives argue that negative net worth in a paper money-printing central bank doesn’t matter and that no one will care if the Fed is technically insolvent. They may be right, even though the Fed’s losses are borne by America’s taxpayers and increase the government’s budget deficit and the national debt.If, in any event, the Fed is convinced that no one cares, why would it bother to hide the true capital and call into question its accounting probity? If you are the greatest central bank in the world, the least you can do is keep accurate books. The Fed should report the true capital number. The Congress has oversight authority and responsibility for all aspects of the Federal Reserve, including its accounting. I believe Congress should investigate the Fed’s accounting and then direct the Fed in legislation how it wishes the books to be kept. The governments of other countries certainly do this.The governing statute of the Swiss National Bank, its central bank, requires the SNB to mark its investments to market and reflect the results in its profit and loss statement and its capital. If the Fed had been required to do this, its reported capital at year end 2024 would have been negative $1.2 trillion.The Bank of Canada is required by the Bank of Canada Act to follow generally accepted accounting principles, which in Canada means International Financial Reporting Standards. As these are applied, the Bank of Canada has been reporting that it has negative net worth — as it does.Congress could fix the Fed’s wayward accounting by instructing the Federal Accounting Standards Advisory Board, which issues official accounting standards for government entities, to develop accounting standards for the Federal Reserve.It could also authorize the Government Accountability Office, the government’s chief auditor, to audit the books of the Fed in accordance with such standards. No government entity, especially one with losses counted in hundreds of billions of dollars, should be writing its own accounting rules.

The Federal Reserve’s Accounting for Its Own Losses Is Emerging as an Embarrassment That Only Congress Can Fix

The Federal Reserve’s Accounting for Its Own Losses Is Emerging as an Embarrassment That Only Congress Can Fix

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