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Tuesday, January 12, 2010

The Mysterious Profit of the Fed

Looks like one bank in particular had a good year in 2009.

The Federal Reserve made a record profit of $46.1 billion last year, reflecting money made off its extraordinary efforts to rescue the country from the worst economic and financial crisis since the 1930s, the central bank announced Tuesday.

The windfall gets turned over to the Treasury Department.

It marks the biggest profit on record dating back to 1914 when the Fed was created. The previous record profit -- of $34.6 billion -- was registered in 2007. In 2008, the Fed reported a profit of $31.7 billion.

The Fed says the bigger profit was primarily due to increased income from the securities it held last year.

Now, if we follow the money here, it leads to an interesting place. The Fed made a whole lot of money this year because the debt securities it owned from previous years increased in value. How did they increase? Remember, at the end of 2008, the Fed promised, and delivered, to buy trillions of dollars worth Fannie/Freddie and U.S. Treasury bonds. By doing so, it lowered interest rates in a dramatic way and it increased the value on all debt securities dramatically. (if you have a treasury bond paying 5% and current bonds only pay 4% yours is that much more valuable) So, the Fed's own market manipulation contributed in a large way to its own profitability.

Keep in mind that the Fed has the power to create money out of whole cloth. That's what it did and used that money to buy trillions worth of bonds at artificially low levels. That's the real story. Of course, the Fed is now sitting on trillions worth of bonds at artificially low rates. At some point, they will need to take a lot of this money out of circulation and sell these bonds back into the market. We can expect those years to hit the Fed as hard as their manipulation helped this year.

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