The Riskiest, Most Profitable Bank of All

Large banks will put up strong numbers for 2009, enhanced by the steroids of a zero-interest rate policy and other policy accommodations. But one bank really shot the lights out, with an annual profit in excess of $50 billion -- about five times what Goldman Sachs (NYSE: GS  ) is expected to report. In case you're wondering, that bank is our Federal Reserve.

Before reward, there is risk
Before we start whooping and cheering that performance, it's worth taking a look at the risks that go along with it. During the credit crisis, the Fed dramatically expanded the size of its balance sheet, which now exceeds $2 trillion. With a total assets to capital ratio of nearly 43:1 as of Jan. 6, the Fed looks as highly leveraged as any investment bank at the height of the credit bubble, and much more so than major financial institutions now:

Company Name

Total Assets / Total Equity [Latest Quarter]

Fannie Mae (NYSE: FNM  )

NM*

Morgan Stanley (NYSE: MS  )

16.6

Goldman Sachs (NYSE: GS  )

13.5

Citigroup (NYSE: C  )

13.4

JPMorgan Chase (NYSE: JPM  )

12.6

American International Group (NYSE: AIG  )

11.6

Berkshire Hathaway (NYSE: BRK-A  )

2.3

*Fannie Mae has a negative net worth.
Source: Author's calculations, based on data from Capital IQ, a division of Standard & Poor's.

A run on the (central) bank
With that magnitude of leverage, a small decline in the value of the Fed's assets would suffice to render it technically insolvent. Of course, that risk doesn't have the same consequences as it would for a private institution -- the Fed's funding sources are secure. Nevertheless, investors cannot and will not ignore this massive balance sheet bloat and the risks it presents (consumer and asset price inflation, to begin with). And while the Fed won't suffer the same fate as Bear Stearns, Lehman Brothers or Northern Rock, a run on the dollar (or even just an orderly decline) could turn out to be the direct equivalent of a run on the (central) bank.

The Fed's policies are creating a new set of tangible risks for investors. Motley Fool Global Gains co-advisor Tim Hanson explains why it's time to get out now.

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You can follow Fool contributor Alex Dumortier on Twitter; he has no beneficial interest in any of the companies mentioned in this article. Berkshire Hathaway is a Motley Fool Inside Value and a Motley Fool Stock Advisor selection. The Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletters today, free for 30 days. Motley Fool has a disclosure policy.


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  • Report this Comment On January 14, 2010, at 10:18 AM, dlhdouble wrote:

    Did this article start out by trying to predict the past? "Large banks will put up strong numbers for 2009, enhanced by the steroids of a zero-interest rate policy and other policy accommodations."

  • Report this Comment On January 14, 2010, at 1:49 PM, TMFHousel wrote:

    dlbdouble,

    Full year 2009 results haven't been released yet.

  • Report this Comment On January 15, 2010, at 3:25 AM, xetn wrote:

    What do you mean the Fed's funding sources are secure. The fed can and does create money out of thin air and can purchase any thing it wishes with out any shareholder or auditor oversight. It is a private monopoly made up of the largest banks in the US, legal counterfeiter and source of all the boom/bust cycles since its founding. And it has failed every one of its mandates.

    Just to be clear, here are the Fed's charter/responsibilities:

    According to a Fed publication entitled "The Federal Reserve System: Purposes and Functions”,the Fed "has supervisory and regulatory authority over a wide range of financial institutions and activities." That’s an understatement if ever there was one. Among the Fed’s "functions" are the regulation of:

    Bank holding companies

    State-chartered banks

    Foreign branches of member banks

    Edge and agreement corporations

    U.S. state-licensed branches, agencies, and representative offices of foreign banks

    Nonbanking activities of foreign banks

    National banks

    Savings banks

    Nonbank subsidiaries of bank holding companies

    Thrift holding companies

    Financial reporting procedures

    Accounting policies of banks

    Business "continuity" in case of economic emergencies

    Consumer protection laws

    Securities dealings of banks

    Information technology used by banks

    Foreign investment by banks

    Foreign lending by banks

    Branch banking

    Bank mergers and acquisitions

    Who may own a bank

    Capital "adequacy standards"

    Extensions of credit for the purchase of securities

    Equal opportunity lending

    Mortgage disclosure information

    Reserve requirements

    Electronic funds transfers

    Interbank liabilities

    Community Reinvestment Act sub-prime lending demands

    All international banking operations

    Consumer leasing

    Privacy of consumer financial information

    Payments on demand deposits

    "Fair Credit" reporting

    Transactions between member banks and their affiliates

    Truth in lending

    Truth in savings

    Source: Thomas DiLorenzo: professor of economics at Loyola College in Maryland.

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