Enhancing Transparency and Reducing Risk by Means of Accounting Standards at the Federal Reserve

By Beauchamp, Charles F.; Ford, William F. | The Journal of Government Financial Management, Winter 2011 | Go to article overview

Enhancing Transparency and Reducing Risk by Means of Accounting Standards at the Federal Reserve


Beauchamp, Charles F., Ford, William F., The Journal of Government Financial Management


Since 2008, the Federal Reserve System's efforts to combat the ongoing financial crisis have dramatically transformed its operations. These efforts have varied in form from major asset purchases of collateralized debt obligations to loans to distressed financial intermediaries. This has resulted in major changes in the composition, size and risk profile of the Fed's operations at a time when the Fed is committed to enhancing the transparency of its monetary policy activities. In a 2010 speech, Chairman Ben Bernanke stated, 'Transparency regarding monetary policy in particular not only helps make central banks more accountable, it also increases the effectiveness of policy."1 In keeping with the spirit of enhanced transparency, the Fed continues to report its new activities in its weekly H.4.1. releases and its annual report. Yet, these efforts have not satisfied some congressional leaders, many reporters and a growing cadre of academic economists. We believe this disconnect can partially be explained by the Fed following its own set of inhouse accounting standards, which differ from Generally Accepted Accounting Principles (GAAP).

Originally billed as temporary, with definitive exit strategies, the Fed's crisis containment efforts now appear to be evolutionary, changing as the aftereffects of the crisis linger. In November 2010, the Fed decided to postpone its exit strategies in favor of engaging in prolonged quantitative easing (now billed QE2) by planning to purchase more Treasury securities during 2011.2 These purchases further increase the size and alter the risk profile of its balance sheet. Because of its unique position as the nation's central bank and facilitator of monetary policy, it is imperative that the Fed continue its efforts toward enhancing its transparency. A major step forward would be adopting the same accounting standards it requires of its member banks, that is, GAAP. We provide an explanation of how adopting GAAP standards enhances the transparency of the Fed's growing exposure to credit and interest rate risks and explain how these enhancements decrease the Fed's reputational risk by highlighting both its strengths and weaknesses. We conclude with a summary of our suggestions.

The Fed's Accounting Standards

One of the Fed's major tools of transparency is its annual report where it provides enhanced detail of its operations of the past year. In the Audits of the Federal Reserve System section, the Fed's auditor, Deloitte & Touche, states that "the Reserve Banks have prepared these combined financial statements in conformity with accounting principles established by the Board of Governors of the Federal Reserve System, as set forth in the Financial Accounting Manual for Federal Reserve Banks, which is a comprehensive basis of accounting other than accounting principles generally accepted in the United States of America."3 A major concern of this accounting protocol is that it limits comparability to other central banks and creates difficulties in evaluating the Fed's activities over time as the Fed can and does change its in-house standards between annual reports.4 In regards to the Fed's risk-laden asset portfolio, its non-GAAP accounting protocol also makes it difficult for outsiders to evaluate the Fed's financial performance.

An early provision of the DoddFrank Act called for a one-time audit of the Fed's crisis containment efforts by the U.S. Government Accountability Office (GAO).5 Completed in July 2011, the GAO audit concentrated on the internal controls and risk management practices of the Fed's crisis efforts and found both satisfactory. The GAO made seven recommendations on how the Fed could strengthen its internal controls and risk management practices for future crisis responses. Although the GAO acknowledged the Fed's non-GAAP protocols, adopting GAAP was not one of the GAO's recommendations.6 This "one-time" audit represented a "one-time" solution that would have been unnecessary if GAAP protocols were in place at the Fed. …

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