* Study highlights risk bond buying could lead to losses
* Losses would prevent Fed making payments to Treasury
* Missed payments would risk political interference
By Alister Bull
WASHINGTON, Jan 28 The U.S. Federal Reserve is
paying close attention to risks linked to its bond buying
program, including the possibility of losses on its massive
portfolio that might touch off a political fire storm and harm
the central bank's independence.
A Fed staff research paper released last week highlights a
range of scenarios under which bond buying in 2013 inflates the
danger the Fed incurs a loss.
The central bank regularly returns portfolio profits to the
Treasury and it has never missed a payment before. Last year,
remittances hit a record $89 billion thanks to income from
assets on its balance sheet, which has more than tripled to
almost $3 trillion since the financial crisis struck in 2007.
But the researchers warn the Fed could miss payments for up
to four years under some scenarios.
The Fed has been buying bonds to drive down longer term
borrowing costs after cutting overnight interest rates to near
zero in late 2008 to support a fragile economic recovery.
Minutes of the Fed's last meeting in December unexpectedly
highlighted growing discomfort with the bond buying, currently
running at $85 billion a month, although analysts do not expect
any change to be announced after policymakers gather this week.
A Fed loss, while not meaningful in an economic sense, could
pose a serious political liability that might expose the central
bank to unwelcome scrutiny from U.S. lawmakers, some of whom
have been heated critics of the bond buying.
"While this is of little macroeconomic significance, it will
not go unnoticed," Charles Plosser, president of the
Philadelphia Fed and a noted policy hawk, said in November.
"It is a risk to perceptions about the institution, which
eventually may put the Fed's independence at risk."
Other officials have also voiced a keen awareness of the
potential costs of the asset purchase program, with Fed Chairman
Ben Bernanke going out of his way this month to stress that
these costs, while hard to gauge, would not being ignored.
"We have found this to be an effective tool, but we are
going to continue to assess how effective because it is possible
that, as you move through time and a situation changes, that the
impact of these tools could vary," he said on Jan. 14. "When
something is more costly, you do a little bit less of it."
The Fed, in a statement scheduled to be released after a
two-day meeting at about 2:15 pm (1915 GMT) on Wednesday, is
expected to confirm that purchases will be kept up until it sees
a significant improvement in the outlook for the labor market.
Minutes of its December meeting showed that several
policymakers thought it would be appropriate to slow or stop the
purchases well before the end of 2013, while a few thought they
would be warranted until the end of the year. A few other
policymakers saw a need for considerable policy accommodation,
but did not spell out a time frame in which to end the
The Fed staff research paper examined three scenarios for
the balance sheet: no additional increase in its size in 2013,
further growth of $500 billion, and further growth of $1
The researchers, Seth Carpenter, Jane Ihrig, Elizabeth
Klee, Daniel Quinn and Alexander Boote, then calculated what
would happen to Fed income as the central bank began to exit
from its extraordinary policy measures and raise interest rates.
Assuming rates rose at the pace economists now expect, Fed
payments to the Treasury would stay high through 2015, but would
then be halted for several years if the balance sheet grew by
either $500 billion or $1 trillion in 2013, according to the
paper. Under the third scenario, in which no more assets are
added in 2013, there was no halt in payments.
If the balance sheet grew by $1 trillion, the research paper
calculated that payments would be suspended for four years and
the loss would peak at $45 billion in 2019.
The losses would be even deeper if interest rates rose
significantly faster than anticipated.
According to the simulation run by the Fed staff, the loss
could spike as high as $125 billion in 2019 if 10-year rates
were 1 percentage point higher than the consensus of the Blue
Chip survey of private economic forecasters, which the paper
used as its baseline.
Such losses would not hurt the Fed's ability to conduct
monetary policy, the researchers emphasized. Also, they could
easily be offset by the benefits of stronger growth if the bond
buying succeeded in spurring economic activity, which would
broadly lift tax receipts to the Treasury as household income
and corporate profits rose.
Furthermore, a halt in Treasury payments would be more than
made up by the much larger cumulative Fed remittances to the
public purse over the period covered by the study, which goes
The paper estimates remittances to total $720 billion from
2009 to 2025, or $40 billion a year, compared with Fed payments
to the Treasury of $25 billion a year before the financial
crisis. So even if there are losses, the Fed will pay more money
to the Treasury over the longer run due to its bond purchases.