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Stop The Presses: The Fed Can Fund The Treasury With Over Half A Trillion In Emergency Capital

Zero Hedge
Thursday, July 28, 2011

By now some readers may have read ludicrous stories about the Fed coining multi-trillion precious metal coins in a way to loophole the debt ceiling situation. Granted, this plan is so far beyond ridiculous that we have not wasted the time to comment on it. That, however, does not mean that the Fed is powerless to assist the Treasury in a modestly long-term term fix of the debt ceiling fiasco. In fact, as Stone McCarthy’s Raymond Stone observes: “The Fed does not want to be a player in this debt ceiling/potential default debate. It didn’t want to be a player in the Bear Stearns debacle, or the Lehman situation. But when push comes to shove the Fed will do what it can to avoid a default.” In summary there are three avenues that the Fed can pursue in order to help Tim Geithner prolong the cash illusion modestly longer. The three options for Bernanke are to i) book profits; ii) prepay expenses and, yes, iii) sell gold. Combined, these three approaches could squeeze out well over half a trillion dollars, giving the Treasury breathing room not only past August 2, but potentially into 2012! That said, “The Fed would not want to advertise to Congress the possibility of delaying default. It does not want to take Congress off the hook on increasing the debt ceiling.” But it will, if it has to, and the end result will be a delay potentially of up to a month. And if it means selling off the Fed’s gold, so be it.

The three plans in detail from Stone McCarthy:

Book Profits

The Fed holds roundly $2.6 trln in the System Open Market Account (SOMA). Some of these securities were purchased at a time when market interest rates were substantially above current levels. This subset of SOMA represents securities on which the Fed has unrealised profits. Prior to the onset of the crisis the Fed held roundly $160 bln of Treasuries with maturities in excess of 5 years. These securities have accrued substantial unrealized profits

Stop The Presses: The Fed Can Fund The Treasury With Over Half A Trillion In Emergency Capital SMRA%20book%20profits
The Fed could sell some of these securities, book the profits, and then repatriate those profits to the Treasury. If desired, the Fed could reinvest the par value of those securities back into newer Treasuries to maintain the par value of its holdings.

Prepay Expenses

Every week the Fed repatriates its profits to the Treasury. The weekly profits of the Fed largely represent the weekly accrued interest income from the Fed’s SOMA, minus interest expense, operating expenses and accrued dividends.

Stop The Presses: The Fed Can Fund The Treasury With Over Half A Trillion In Emergency Capital SMRA%20exp%202 0

In 2010 the Fed repatriated $79.3 bln of profits to the Treasury. Effectively the accrual of monies to be paid to the Treasury shows up in an expense account (liability) Interest on Federal Reserve Notes (IOFRN). When the payment is actually made to the Treasury each Wednesday, the IOFRN liability on the Fed’s balance sheet is reduced and the Treasury deposit account at the Fed is increased by a similar amount.

Stop The Presses: The Fed Can Fund The Treasury With Over Half A Trillion In Emergency Capital SMRA%20exp%203

Over the first 6 months of calendar year 2011 the Fed remitted $46.1 bln to the Treasury, up from $35.3 bln in the comparable period of 2010. In other words, in 2011 the Fed’s repatriated profits to the Treasury have been on track to bypass the $79.3 bln of 2010.

Could the Fed prepay IOFRN to the Treasury? In other words, could the Fed pass along profits before the income is actually accrued on the Fed’s books? We think the answer is yes, but are not certain. Effectively this would be similar to prepaying any other Fed expense, such as payrolls, rents, etc.

This transaction would effectively reduce the IOFRN liability into negative territory, while increasing the Treasury’s deposit by a similar amount. One liability goes down and another goes up.

Gold

The Treasury holds 261,498,899.316 troy ounces of Gold with a book value of $11.041 bln at $42.22/oz. The Treasury has monetarized this gold by issuing to the Federal Reserve gold certificates in an equal amount ($11.041 bln). The monetarization of gold effectively was an accounting entry providing an increase in Fed assets (gold certificates) and an associated increase in the Treasury’s cash deposit at the Federal Reserve.

The $42.22/oz official price of gold was last set in 1973. Given that gold is trading above $1,600/oz could the Treasury prevail upon Congress to increase the official price? Would Congress respond under the Gold Reserve Act of 1934? If the official price were reset to $84.44/oz (doubled) the Treasury’s deposit at the Fed would rise by $11.041 bln.

The Treasury could elect to de-monetarize gold, taking back the gold certificates from the Fed, and having its cash position reduced by $11.041 bln. After de-monetarizing gold the Treasury could presumably sell gold on the open market. Undoubtedly, such sales would drive the price of gold down from over $1,600/oz, but presumably the Treasury would be able to get a good deal more than the current official rate of $42.22 oz.

So there you have it: combined across all there alternatives, the Fed could probably generate over half a trillion in emergency cash, which would last the country well into next year! So perhaps everyone should immediately forget the relentless lies and fearmongering from Tim Geithner (who could not possible see a US downgrade from AAA as recently as three months ago, which is now imminent) and force the Fed to actually help the one entity that it is supposed to help: the United States, instead of the likes of Goldman Sachs or JP Morgan.

Yes, in the process the Fed’s barbarous relic “tradition” will be sold off and the market price will plunge, only to subsequently explode to record highs (although we expect that gold would be then be confiscated from the broader population), but at least in the process this will allow the politicians to finally resolve the long-term problems of this country in whole, instead of the proposed partial resolutions that do nothing but at best slow the rate of debt accumulation.

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