Posted on 02/02/2023 6:31:34 AM PST by Heartlander
Before new trillion-dollar federal spending bonanzas became a regular occurrence, the Federal Reserve’s announcement that it lost over $700 billion might have garnered a few headlines. Yet the loss met with silence. Few Americans have noticed the huge increase in both the scale and the scope of the central bank or the dangers that it poses to the American economy. As Fed-driven inflation becomes the Number One political issue in America, that will change.
The Fed’s losses owe to a shift in the way it does business. Before the 2008 financial meltdown, the central bank tried to control interest rates by buying and selling U.S. bonds. A few billion in purchases or sales could move the whole economy, and this meant that the Fed, which operates much like a normal bank, could keep a relatively small balance sheet of under $1 trillion.
Since the financial crisis, the Federal Reserve, like other developed-world central banks, has used a different playbook. It provides enough funds to satiate the entire banking world, and it seeks to adjust the economy by paying banks more or less interest to hold those funds. These payments keep private-sector interest rates from dropping too low. When it first undertook this “floor” experiment, the Fed’s balance sheet exploded to more than $4 trillion. After the Covid pandemic, it approached $9 trillion.
A larger balance sheet means greater risks. And the Fed has added to that risk by purchasing longer-duration assets. Pre–financial crisis, the Fed bought mainly short-term federal debt. Only about 10 percent of all the U.S. bonds owned by the central bank lasted longer than ten years. Now, that figure has risen to 25 percent.
Moreover, starting in 2008, Fed banks began buying mortgage-backed securities, mainly from Fannie Mae and Freddie Mac. The Fed now holds more than $2.5 trillion of such mortgage bonds, and almost all those mature in over ten years. Today, nearly half the Fed’s assets won’t come due for another decade.
Such longer-term debt poses a particular danger. As the Fed pushes up interest rates, the old, low-interest debt that the central bank purchased loses value, leading to those hundreds of billions in losses. Economists Alex Pollack and Paul Kupiec warn that true Fed losses are over $1 trillion and will increase as interest rates keep rising.
The Fed is not just losing value on its old assets; it has started paying out more money than it takes in, every day. The interest rate that the Fed pays to banks in its new “floor” system has risen to over 4 percent, but its older mortgage and Treasury securities earn only about 2.3 percent. The longer the high inflation and high rates continue, the more the Fed will lose.
During the pandemic, the Fed also started buying riskier assets than U.S. bonds and semipublic mortgages. In 2020, it began supporting junk bonds, auto loans, student loans, and even credit-card loans. The Fed also created a “Main Street” program to supply direct loans to small and medium-size firms, including some nonprofits. This program has already suffered $50 million in loan losses, and a December report noted that the Fed expects to lose $1.4 billion in defaulting and bad loans.
Like a normal bank, the Fed has capital—the money provided by its owners in exchange for stock. Those “owners” are the private banks that joined the Federal Reserve system and that can earn dividends on their stock. Yet the Fed’s hundreds of billions of losses on Treasuries, mortgages, and other programs have swamped its meager $40 billion in capital. From any normal perspective, the Fed is underwater or bankrupt. Of course, unlike most banks, the Federal Reserve can survive such losses. It is the only institution in America that prints its own budget. Every year, the Fed pushes trillions of dollars into the economy, and then decides to keep $6 billion or so for itself and its 23,000 employees. If it is short on cash, it can just make more.
But the Fed’s gargantuan losses come with real consequences. In recent years, the central bank has sent up to $100 billion a year in “profits” to the U.S. Treasury, a not-insignificant share of federal revenue. In September, the Fed’s gift to the Treasury dropped to zero for the first time in more than a decade. The Fed’s growing losses mean that it may stop paying money into the Treasury until 2030, or longer. Congress and the American people will become concerned when they learn that the Fed is paying tens of billions of dollars in interest to banks—including many foreign ones—directly out of new money that it creates, even as it cuts off funds to the government.
Congress will also miss out on the chance to treat the Federal Reserve as a piggybank to raid. In 2015, Congress took $20 billion of the Fed’s capital to fund a highway bill. Congress also put the Consumer Financial Protection Bureau (CFPB) under the Federal Reserve’s purview and let the agency write its own paycheck using free Fed money. If Fed losses continue, the CFPB’s $600 million annual budget could be threatened (though a recent federal court ruling striking down the budget gimmick might stop it first).
The Fed will likely print more money to pay for its losses and the interest and dividends to banks. But keeping the money spigot flowing as inflation continues and the federal budget comes under duress will put the Fed in a political bind. A decade ago, Jerome Powell, then a member of the Federal Reserve Board, warned that under the expanded floor system, the Fed might start “paying billions of dollars of interest to our largest financial institutions and nothing to the taxpayer in a time of fiscal austerity.” That day is here, and Chairman Powell is doubtless lamenting it.
The Federal mortgage companies, Fannie, Freddy, ..... have $12 trillion maturing within 2 years.
They financed short term all the mortgages that they lent out for 30 years at 3% to 4%.
That means they are already upside down on these mortgages and can end up paying many times the interest rate they collect on the fixed rate 30 year mortgages.
The US has $24 trillion due in 2 years and must refinance at much higher rates.
We as a country have pretty much financed our debt on credit card terms!
I don’t fully understand this, but it sounds more and more like a fraud scheme to me. The USA is on the hook.
The Federal Reserve has been kicking back its profits to the US Treasury every year. Roughly 100 billion per year. This year there are no profits to send back. This looks doom laden to me.
Can a Freeper post more details on this?
I’m no economics guy, but I keep thinking about 2008. Easy money all over the place through generous lending on mortgages. No Income, No Job? Here’s your mortgage. It was a house of cards supported by mortgage-backed securities and derivatives that almost no one understood. At some point interest rates went up, everything was underwater, and the value dropped out of the system.
As far as I know, mortgages are not likely to be the problem this time around. It’s a different game now, and real estate is probably about as solid as it needs to be.
But how about other sectors?
I just get the feeling that, one way or another, it’s still a house of cards, and the supply chains are going to fail and it will be another set of dominoes and it’s going to be real ugly. And this time, it’s on purpose. That’s your Great Reset. They mean for this to happen.
....Drug dealers and hookers hardest hit.
It’s not fraud, and it may not even be a problem.
If you own a bond paying 2% interest and current rates rise to 4%, then your bond loses value simply because other similar investments offer a higher yield. If you want to sell your 2% bond today, you might only get (for example) 75% of its face value. In theory, you’ve “lost” 25% on this investment. But that’s only if you sell it today. If your bond is a 10-year Treasury bill and you hold it until it matures in the future, then you won’t really “lose” anything at all.
I’m totally shocked by what you wrote.
Unless something is done (such as bringing federal finances into balance) the financial system is likely to burst.
“you won’t really ‘lose’ anything at all”
Purchasing power is lost.
Purchasing power today means nothing in a long-term investment horizon. That’s why investors still buy government bonds paying 3% even when the reported inflation rate is 6% or higher.
NY’s Princess Kathy just proposed a $227 BILLION dollar annual budget. That’s criminal.
” then you won’t really “lose” anything at all.”
You are forgetting the collapse in the value of the dollar. That is coming at a fast rate.
We are having in the neighborhood of 20% inflation. No government security can hold against that loss.
Borrowing short and lending long at low rates is a recipe for disaster.
You are correct..
There are two factors.
1. The present value(at market rate) of the stream of interest payments based upon the original document.
2. The present value(at market rate) of the face amount at maturity.
If it’s a long term bond and market interest is 4% on a 2% bond, the bond would be discounted 50% so the old payment amount is now equal to the new market yield.
“and this meant that the Fed, which operates much like a normal bank”
Tell us that you haven’t the slightest idea of what you are talking about without using those exact words.
The Fed is the nation’s monetary authority, it’s not remotely like a normal bank. The bonds that it holds are used to adjust the money supply in the banking system.
It buys bonds to increase the money supply, it sells them to sop up dollars and reduce the quantity of money.
The bonds that it holds are for this purpose, it doesn’t actually own them. So anything that it earns beyond salaries and normal expenses reverts to the Treasury.
The author’s idea that the Treasury is dependent upon this Fed money is a bunch of nonsense. It’s always money going in a circle; the Treasury pays interest on its bonds that the Fed holds, and the Fed gives that money right back to the Treasury.
The discount wouldn't be that large.
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