It’s Just Accounting

The Federal Reserve (FED) is funding various loan facilities for corporate and other business enterprises which are struggling in the midst of the Coronavirus. The Treasury Department will backstop these loans with $454 billion, certainly more to come, if needed, which will protect the FED from losses which may occur on these loans.

So it goes like this: without the $454 billion Treasury safeguard, a loss of $454 billion would create a hit to the FED’s balance sheet of $454 billion. This would overwhelm the FED’S shareholder equity of roughly $39 billion and result in negative equity of $415 billion ($39 billion equity minus $454 billion loss); or, stated differently, the FED’s liabilities would exceed its assets by $415 billion. Not to worry, the FED has an accounting maneuver in place for such an occurrence. It is called a “deferred asset” account.

The deferred asset account would take the negative equity of $415 billion and turn it into an asset. That’s right, an asset. Consider going to your banker and telling your banker that your liabilities exceed your assets but that is actually an asset. Anyways, this maneuver enables the FED to balance its balance sheet. The balance in this account is to be paid-down through future FED earnings. This affects the Treasury Department because FED earnings are paid-over to the Treasury Department at the end of its fiscal year. So FED losses become Treasury losses because the FED’s future earnings equal to its losses are not turned over to the Treasury Department.

Under the current Treasury backstop of $454 billion for the FED’s current spate of loans, the Treasury, through whatever mechanism or mechanisms necessary, will cover the losses on these loans so that the losses don’t end-up in the deferred asset account. So as you can see, the Treasury, i.e., taxpayer, loses either way. Either FED losses go into the deferred asset account and the Treasury will forgo futures earnings until the account is paid-down, or it directly covers losses through other mechanisms associated with loan programs.

There is no suggestion here that the FED shouldn’t step-in and rescue the world. How to pay for it, however, is another matter. The FED creates its own money, through computer keystrokes, so the availability of money is not an issue, it’s just about the accounting. The suggestion here is that instead of transferring loan losses to the public via deferred asset accounting or other measures currently being set-up during the crisis, the FED should set-up another asset category in order to keep its balance sheet in balance. The assets acquired through the FED’s current loan programs are financial and social stability, intangibles, kind-of like “goodwill” on a private sector business balance sheet. It would seem that a public sector institution should also be able to include a public good intangible on its balance sheet. With this in mind, the FED could set-up an account, perhaps entitled: the “Social Stability” asset account, or, my favorite, “Prevent a Revolution” account, with a value equal to losses incurred during the current lending programs. With no deferred asset accounting, i.e., no negative equity, and no transfer of Treasury payments to cover loan losses, there would be no hit to the U.S. taxpayer.

I am not an accountant, but it seems, if the FED can take losses which result in negative equity and turn this into an asset on the balance sheet, it should be able to create an asset account, equal to its loan losses, but which is associated with real value: financial and social stability. This would enable the Fed to balance its Balance Sheet with positive equity and without a corresponding cost to the taxpayer.

Why not? It’s just accounting.

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