Fed Doesn't Live by the Rules It Sets for Banks

What's good for the goose is good for the gander? This proverb does not apply if the gander is the Federal Reserve and the geese are all the other banks in the country.

Michael Gibson, the Fed's director of the Division of Banking Supervision and Regulation, recently testified to Congress on imposing the Basel III capital rules on all U.S. banks. The Fed supports these rules.

Specifically, Mr. Gibson pointed out that Basel III requires unrealized losses on some securities to reduce the banks' regulatory capital as such losses already reduce their book net worth. In ironic contrast, the Fed itself, which owns $900 billion of mortgage-backed securities and $1.7 trillion of Treasury notes and bonds, never recognizes any unrealized losses in its capital accounts. The Fed sets its own accounting rules for itself, unlike anybody else.

But the Fed's accounting rules go far beyond this. Since 2011, upon realizing it might one day be facing losses on its now massive investment portfolio, the Fed has provided itself a handy rule by which even realized net losses would not affect the capital on their financial statements. Any such losses would be booked in a deferred asset account, instead of properly reducing retained earnings and net worth.

The Fed has a combined net worth of $55 billion, according to a recent report. Anywhere in the world, if you had $55 billion in capital, and then (for example) lost $55 billion, your capital would be zero. But under the Fed's own special accounting rule, if it lost $55 billion, its capital would still be $55 billion. If it lost $75 billion, its capital would still be $55 billion. If it lost $100 billion, its capital would still be $55 billion. It wouldn't, in reality, of course, but it would on the Fed's accounting books.

Mr. Gibson, what would you say if any one of your regulated banks tried that one?

In its defense, the Fed asserts that as the U.S. central bank, it is unique and therefore should have unique accounting. Well, it certainly is unique among banks in getting to write its own accounting rules for itself. But in the logic of whether losses reduce your capital, the Fed is exactly the same as everybody else in the world: they do.

Mr. Gibson, as a top banking supervisor, what do you think of this remarkable accounting rule that the Fed has set for itself? Pretty indefensible, wouldn't you say?

Alex J. Pollock is a resident fellow at the American Enterprise Institute in Washington, DC.