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Post GARBAGE: The Fed's Shady Accounting Procedures (from Ric Mauricio)
Created by John Eipper on 08/03/22 3:30 AM

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GARBAGE: The Fed's Shady Accounting Procedures (from Ric Mauricio) (John Eipper, USA, 08/03/22 3:30 am)

Ric Mauricio writes:

I agree with Michael Frank (July 16th) that the Fed does influence the supply and demand.

What's interesting are the Fed's "one-sided" journal entries.

First, let's back up a little here.

Currently the GAO (and the accounting firms brought in to audit the books) are prohibited by law from auditing four areas of the Federal Reserve:

1) Transactions for or with a foreign central bank, the government of a foreign country, and private international financing organizations.

2) Deliberations, decisions, or actions on monetary policy matters, including discount window operations, reserves of member banks, securities credit, interest on deposits, and open market operations.

3) Transactions made under the direction of the Federal Open Market Committee.

4) Specific parts of a discussion or communication among or between members of the Board and officers and employees of the Federal Reserve System.

It appears that instead of utilizing GAAP (Generally Accepted Accounting Principles), the Federal Reserve is utilizing Generally Accepted Reserve Banking Accounting with Governance Exemptions. OK, so that's a mouthful, so let's use an acronym: GARBAGE.

Here is former Chairman Bernanke's explanation on how the Fed works.

"Now, you might ask the question, well, the Fed is going out and buying 2 trillion dollars of securities--how did we pay for that? And the answer is that we paid for those securities by crediting the bank accounts of the people who sold them to us, and those accounts, at the banks, showed up as reserves that the banks would hold with the Fed. So, the Fed is a bank for the banks. Banks can hold deposit accounts with the Fed, essentially, and those are called reserve accounts. And so, as the purchases of securities occurred, the way we paid for them was basically by increasing the reserves that banks had in their accounts with the Fed.

"This is the liabilities side of the Fed's balance sheet. Of course, assets and liabilities (including capital) have to be equal. So, the asset side had also to rise 2 trillion dollars."

Now here's where it gets interesting. Banks, utilizing their reserves at the Fed, lend out funds to real estate investors/buyers and commercial loans to businesses. Therefore, a mortgage-backed security is created or commercial loan equivalents and that in turn is sold to the Federal Reserve, which in turn increases the bank's reserves. Thus, debit assets with those securities and credit liabilities with bank reserves. Ah, good old double-sided accounting. By the bank doing this over and over again, increasing the securities on the Federal Reserve's balance sheet, as well as the liabilities, the money supply will keep growing. The Fed will control the issuance of these securities by raising or lowering interest rates as well as reserve requirements. But if the Fed makes it too restrictive (by raising the interest rates to where it inhibits borrowers), it will cause banks a bit of pain as well as the real estate and business economy. So, the money supply growth will experience a bit of ebb and flow, but slowing it down to a deflationary scenario would be painful, very painful. Therefore, in order for any economy to continue to grow, it inevitably has to increase money supply, which of course, is inflationary.

It is the rate of inflation that is the bugaboo. If earnings, individuals or corporations, cannot keep ahead of inflation, it is not beneficial to the economy. Thus, the managers of the Federal Reserve walk a tightrope between too little or too much money growth. What does this mean for individuals? It means you must somehow keep ahead of inflation. Keeping one's money in cash will result in a depreciation of your financial well-being. Cash is not an investment. It is a tool. It facilitates an exchange of goods and is very good at doing its job.

We just had an election to determine the contenders for some very important political positions a few weeks ago here in California. One person is running for office as a Republican.  I knew him when he was sitting across from me in our brokerage firm bullpen. I recall him making a cold call and telling the person on the other side of the phone that a Limited Partnership was like a money market fund. When he hung up, I made the comment, "Really?" Ah, yes, he is now aspiring to an office that would make good use of his ability to "bend the truth." As I've always said, politics is actually spelled incorrectly. It should be "polytics." Poly meaning "many." And "tics" are blood-sucking parasites. I really have to shake my head when I see people doing this. And I really shake my head when I see people who believe in these people.

JE comments:  GARBAGE in, GARBAGE out?  Ric, I'm not sure I understand every detail of these accounting shenanigans, but one point rings clear:  it's good to be the Fed.

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  • How the Fed Really Works; from Michael Frank (John Eipper, USA 08/04/22 4:33 AM)

    Michael Frank:

    I don't think you should characterize it as "shenanigans," or garbage, it's just the way central banks work.

    Essentially, the central bank can create cash out of thin air--or make it vaporize--in order to achieve their monetary goals. Printing is the power of the Fed alone. So no, it's not GAAP. Somewhere in the economy, someone needs this power, or you wouldn't have an elastic currency.

    Why isn't the GAO allowed to audit Fed transactions? Actually, I have to do some research.  I'd be surprised if GAO had any audit authority over the Fed. The reason I say that is that despite the "federal" moniker, the Federal Reserve isn't a governmental organization. The regional Fed branches are owned and staffed by the banking industry as self-regulatory organizations, the evolutionary successors to the 1910's bank clearing houses. Only the chairman and Fed board are nominated by the President and confirmed by the Senate. Most Fed nominees come from the regional branches or are academic economists, Powell is an outsider. The monthly appearance of the Fed chair before the various congressional banking committees is voluntary. Like the periodic arguments over the debt ceiling, it's a dog-and-pony show that's more bad habit than good governance. The libertarian whine over auditing the Fed is in the same vein. Details of the Fed balance sheet are out in the great wide open; anyone can review them and reverse engineer the transactions down to the individual cusip. It's pretty dull stuff:


    Revealing the details of discount window operations even in an audit would risk a general banking panic, as only the desperate go there to borrow. If you know your bank is dependent on the discount window, you should leave, as would all the other depositors, causing a run.

    As for financial services people "bending the truth," a word to the wise: every customer-facing position in financial services, from the bank guard to the hedge fund manager, every job you can think of, is a sales position. If you're wondering who you can trust, the answer you don't want to hear is that you can't trust anyone. This is because only way to make a living in financial services is by getting customers to leave some of their money on the table. Sometimes it works in your favor, but there are no true fiduciaries. The only defense you have is to take the time to understand your own personal finances. If you walk out of the meeting thinking, thank my lucky stars that that guy is looking out for me, his hand is already deep in your purse. The US educational system is incompetent when it comes to teaching banking and investment.  We graduate into the world with a diploma in financial ignorance.

    Which dovetails into the news. My personal opinion, make your own judgement: we are in the midst of an irrational bear market rally. Why don't I think this is the real thing? Because Powell's message was miscombobulated by market pundits and dreamers. What Powell said was that he had achieved his "neutral rate" and Fed policy going forward would be "flexible." This was widely interpreted as Fed capitulation. To be fair, Powell had done just that in 2017. But inflation wasn't running at 9% back then. "Neutral rate" is a sort of code phrase, which evokes the "Taylor Rule." This is a pseudo-scientific methodology that suggests that there is a neutral interest rate at which the economy will be in perfect equilibrium, neither growing nor shrinking. And that central bank policy should vary nominal rates up or down around the neutral rate to control inflation. So by achieving neutral, Powell was actually saying, "now we start," not "now we're done." I could be wrong, but the Fed may deliver an ugly surprise next month. Powell still has to atone for the fastest increase in money supply in history.

    JE comments:  Michael, you have identified a gaping hole in our education system.  What are your reflections on what a financial literacy curriculum should look like?

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    • Ric Mauricio Creates Dollars out of Thin Air (John Eipper, USA 08/06/22 4:06 AM)

      Ric Mauricio writes:

      From the Federal Reserve website:

      "The Federal Banking Agency Audit Act (Pub. L. No. 95-320) authorizes the Government Accountability Office (GAO) to audit certain aspects of Federal Reserve System operations. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, as well as the Coronavirus Aid, Relief, and Economic Security Act of 2020, directs the GAO to conduct additional audits with respect to these operations.

      "The Board of Governors, the 12 Federal Reserve Banks, and the Federal Reserve System as a whole are all subject to several levels of audit and review:

      "The Government Accountability Office (GAO) conducts numerous reviews of Federal Reserve activities every year.

      "The Board's financial statements, and its compliance with laws and regulations affecting those statements, are audited annually by an outside auditor retained by the independent Office of Inspector General (OIG). The results of this independent audit are released to the Congress and the public.

      "The Board's OIG conducts independent audits, evaluations, and criminal investigations relating to the programs and operations of the Board, as well as those Board functions delegated to the Reserve Banks. Completed OIG reports are publicly available as well as a dynamic Work Plan that lists all of the OIG's ongoing and planned audit and evaluation work. In addition, completed and active GAO reviews and completed OIG audits, reviews, and assessments are listed in the Board's Annual Report.

      "The financial statements of the Reserve Banks are also audited annually by an independent outside auditor.

      Each week, the Federal Reserve publishes its balance sheet and charts of recent balance sheet trends; it also provides an interactive guide to the Fed's balance sheet. The balance sheet is included in the Federal Reserve's H.4.1 statistical release, 'Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks.'

      "In addition, the Reserve Banks are subject to annual examination by the Board. The Board's financial statements and the combined financial statements for the Reserve Banks are published in the Board's Annual Report."

      So, yes, the Federal Reserve is not a government entity, but banking, whether it be the Federal Reserve or its member banks, is subject to government oversight, otherwise it would be a laissez-faire, anything-goes type monetary system. Oh, a little like cryptocurrency. In fact, since most dollars are digital, one may label any fiat currency as crypto currency.

      By the way, the Federal Reserve does not print money. Only the US Treasury can print money.

      But the Federal Reserve does assist in creating money, by as Michael Frank put it, "creating money out of thin air." Although it is actually the banks creating money out of thin air by lending money and creating either mortgages or commercial paper, which they, in turn, sell to the Federal Reserve.

      Oh, I just thought of something. What if I bought a piece of property (or a business), improved it, and sold it for a profit, but took as part payment a written agreement (yes, a mortgage-backed security or commercial paper), and turned around and sold it to the Federal Reserve (or anyone who will buy it) and they in turn credited my bank account with the digital US Dollars. Did I not just create value out of thin air? Are those dollars created out of thin air?

      Do you know what is really "thin air?" I form a company. I create a story. I still don't have profits, but a promise of profits. I go public via a listing on one of the major exchanges or a SPAC. Voila. Dollars out of thin air. Or I create a crypto currency or non-fungible token. I list it on an exchange. You buy it. Voila! Instant dollars. I love it.

      JE comments:  I love it, too.  The best "thin air" scheme I can think of is the NFT (non-fungible token).  Click below for the 10 most expensive NFTs ever.  I simply don't get it:

      10 Most Expensive NFTs Ever Sold [June 2022 Update] (sensoriumxr.com)

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