The Budgetary Impacts of Fed Actions

Yesterday CBO issued a very interesting report on the budgetary impact of the Federal Reserve's actions to address the economic and financial crisis. Besides giving a very useful background on the Fed's extraordinary actions (which we've talked about here) and its more traditional policy controls, CBO estimates that remittances from the Fed to the Treasury will grow from about $34 billion in 2009 to over $70 billion in 2010 and 2011.

Each year the Fed is required to remit any excess income (income minus expenses, dividends to banks, and additions to it surplus account) to the general fund of the Treasury, where it appears as a type of revenue under "miscellaneous receipts." Between 2000 and 2009 remittances ranged from $19 billion to $34 billion.

Due to the Fed's actions to stabilize the economy and financial sector (including expanded lending to banks, new liquidity programs, open-market purchases of securities, and support for systemically important institutions -- see a full list and descriptions at Stimulus.org), remittances are expected to more than double over the next few years as the Fed's asset portfolio remains large (according to Stimulus.org, the Fed's balance sheet is currently nearly $2.4 trillion) and returns on these assets remain higher than interest rates the Fed pays on reserves.

But the Fed's asset portfolio is now much riskier than before. Before the crisis, U.S. Treasury securities made up almost all of the Fed's assets. Now, Agency debt and MBSs constitute the majority of assets held. 

But there's another part of the story here. The projected increased remittances to the Treasury fail to fully account for the costs to the taxpayer of the Fed's actions. Since the Fed purchased some of these assets at prices higher than what private investors would have, taxpayers receive less of a return for their money. As CBO explains:

If the Federal Reserve purchases the security at a fair market price, equivalent to what private investors would have paid, then the purchase creates no economic gain or loss for taxpayers; the price compensates the central bank for the risk it has assumed. By contrast, if the Federal Reserve purchases a risky security for more than the amount that private investors would have paid, it gives a subsidy to the seller of the security, creating an economic loss, or cost, for taxpayers.

Using "fair value" subsidies conferred by the Fed, CBO estimates that the Fed's actions totaled about $21 billion. CBO does note, however, that these fair value estimates focus on the costs and not the benefits of the Fed's actions, arguing that the benefits likely "exceeded the relatively small costs reported here for fair-value subsidies."  

So, it's clear that the actions of the Fed clearly affect the federal budget, but these remittances do not capture the full extent of the risks and subsidies that the Fed is taking on and dispersing, respectively. It is also unclear whether the Fed's remittances should be shown in the budget as a receipt -- to reduce the deficit -- or as a means of financing -- to reduce the Treasury's borrowing needs.

See CRFB's paper The Extraordinary Actions Taken by the Federal Reserve.