Despite a growing market, officials for the Federal Reserve are contemplating scaling back on their stimulus plan. Experts believe the longer the Fed keeps up with its bond-buying stimulus plan, the less likely they will have extra funds to give to the Treasury Department.
How the Fed came to this situation
In 2008, the Fed acquired debt from The Bear Stearns Cos and American International Group Inc. to bail out the two organizations. The Fed also has been purchasing $85 billion in bonds each month to help grow the economy. The Fed collects interest payments from it holdings of mortgage debt and government securities and uses these payments to fund the operations of its board of governors and 12 regional reserve banks. The remaining balance is then given to the Treasury Department, where it is added to the department's total receipts.
Last year's record profit of $88.4 billion was the highest ever awarded to the Treasury Department. Reuters reported that the record breaking sum came from $80.5 billion in mortgage backed securities and interest on Treasury bonds. Although this is a historic profit, experts fear that continuing this plan will hurt the economy over the long haul.
Changing factors in the economy
A recovering economy and increased interest rates signal that the Fed's bond holdings will drop at the same time its funding costs climb. This is due to the central bank paying interest on the surplus reserves. These factors will result in operating losses and an increased amount of inquiry from opponents of the bong purchasing policy.
These factors are causing some reservation from federal officials, many of whom are curious when the central bank will scale back on the monthly bond purchases. Michael Feroli, chief economist at JPMorgan Chase & Co., told Bloomberg this decision is weighing on the minds of the higher-ups.
"They've done a few things to try to insulate themselves from this concern, but I suspect in the back of their minds it still haunts them," he said. "It's not going to go away."
Concern across the board
Federal Reserve Bank of New York President William Dudley said the traditional monetary policy framework of the Fed has reassured the central bank's overall independence. However, many experts believe the central bank's record balance sheet of $3.85 trillion is contradicts this idea.
"The Fed is a lightning rod: It attracts withering criticism from the Republican base," Greg Valliere, chief political strategist at the Potomac Research Group, told Bloomberg. "So even after several years of turning huge profits over to Treasury, losses would embolden the Fed-haters."
Federal officials have discussed the possibility of scaling back on the number of bonds they purchase each month. Federal Reserve Bank of Atlanta President Dennis Lockhart said the Fed may consider this option.
"I would not take off the table at least consideration at that time," Lockhart said. "The question of changing the mix of accommodative tools ought to be on the table at every meeting for the foreseeable future."
In over its head
Under quantitative easing policy, as the Fed's balance sheet increases, so will the total excess reserves. Feroli said the amount of spending will continue and might start to become too much for the Fed to handle.
"It feels like they've tried to convince themselves this isn't a problem, in part because they came up with this deferred-asset way of looking at operating losses and because they switched to a no-asset-sale approach," he said. "As you add up really big numbers, it does start to creep back into their thinking."