Has anyone noticed that the Federal Reserve
is solvent again? Unlikely, as few realized that it was technically insolvent. At the Sept. 30 reporting date, cumulative unrealized losses in the system’s open market account totaled $66.4 billion, almost twice the $39.1 billion of capital available to absorb that hypothetical loss.These are matters of form, not function, you will hear. The Fed does not mark itself to market. It pays its earnings into the Treasury, rather than retaining them. And it returned to technical solvency in the fourth quarter on the back of the year-end bond rally.
Then, too, in 2011 the Treasury pledged itself to support the central bank in times of trial. Maybe it’s for that reason that Congress raided the Fed for $19.3 billion to fund the 2015 highway act, Janet Yellen vainly protesting that the central bank’s capital account “creates confidence in our ability to manage monetary policy.”
Such capital alone lends no such confidence, but the decapitalization did lift an already elevated ratio of systemwide assets to equity. On March 20, it topped 100:1—10 times the year-end leverage ratio of JPMorgan Chase. In the great cause of financial-institution safety and soundness, the Fed isn’t exactly leading from the front.
Does any of this matter? It used to. A currency once derived its strength from the integrity of the balance sheet of the bank that issued it—the more liquid that institution’s assets, the more plentiful its capital, the more confident the market could be in the ability of the money-holding public to exchange its currency for gold, and vice versa.
That was the classical, white-tie gold standard. Its dress-down successor, the Bretton Woods system
, a gold standard much reduced in starch and rigor, died in 1971. Succeeding it is the paper-money, or blue-jeans, standard. The paper dollar owes its value to the say-so of the government alone.Since 2008, the blue-jeans standard has given way to a kind of knee-ripped jeans standard—quantitative easing, ultralow interest rates, and nonstop “forward guidance,” along with the rest of the bag of worldwide radical monetary-policy tricks.
Under the gold standard, people adjusted their affairs to the fixed value of the dollar. Under the paper system, the Fed adjusts the unfixed value of the dollar to the perceived needs of the people. This is a profound transformation, but it long ago lost its shock value.
The world has likewise become habituated to such Friday-casual accounting metrics as earnings before interest, taxes, depreciation, and amortization, or Ebitda. In decrying that nonorthodox cash-flow substitute in 2000, Moody’s correctly traced it to the leveraged buyout mania of the 1980s. Highly levered companies struggled to meet fixed charges out of the old standby Ebit—earnings before interest and taxes. They covered their interest expense with room to spare by subtracting depreciation and amortization from the classical measure of debt-service capacity. What was the harm? D&A are noncash charges, the investment bankers noted.
“Ebitda can drift from the realm of reality,” the Moody’s analysts, led by Pamela M. Stumpp, replied. Depreciation is real enough for a trucking company with a rusting fleet, or a wireless company with an ageing technology. “Ebitda,” prophetically noted Stumpp et al., “can easily be manipulated through aggressive accounting policies relating to revenue and expense recognition, asset write-downs and concomitant adjustments to depreciation schedules, excessive adjustments in deriving `adjusted pro-forma Ebitda’ and by the timing of certain `ordinary course’ asset sales.”
What’s slack gets slacker. Not even Stumpp anticipated “community-adjusted Ebitda,” the bespoke cash-flow measure of WeWork, the fashion-forward office-leasing company, which the other day somehow reported a 2018 net loss, $1.9 billion, larger than its 2018 revenue, $1.8 billion. Whereas corporate managers once adapted to accounting standards, now accounting standards are adapted for corporate managers.
- Source, Jim Grants via Barrons, read more here
