According to a recent analysis, the Federal Reserve is projected to become technically insolvent within weeks as losses mount on its nearly $9 trillion bond portfolio [1].
This raises important questions about transparency, oversight, and the Fed’s ability to cover its losses by issuing liabilities backed implicitly by taxpayers.
Losses Surpassing Fed Capital
The Fed has already lost around $36 billion this year as it rapidly raises interest rates to fight high inflation [2]. These unrealized losses have consumed about 85% of the Fed’s capital cushion of $42 billion.
According to projections, total losses could surpass the Fed’s remaining capital in mid-March [1].
Once losses exceed its capital buffer, the Fed will have a negative net worth. Only some institutions can operate while insolvent with an explicit government guarantee [3].
The Fed will be uniquely positioned to continue normal operations despite possible Federal Reserve insolvency.
Issuing Reserves to Cover Losses
To pay for its losses, the Fed will issue new reserves to create fresh money rather than buying interest-bearing assets like it typically does [1]. This amounts to printing money to cover its deficits. The Fed will also pay dividends, interest, and bills by issuing interest-bearing liabilities [4].
Unusual Accounting Treatment
Unlike most other central banks, the Fed is booking its losses as a deferred asset rather than reducing its capital [1].
This allows it to report positive equity under accounting rules even as real losses accumulate.
The Bank of England and the European Central Bank are more transparent about losses impacting net worth [5].
Borrowing from Taxpayers Without Oversight
Effectively, the arrangement allows the Fed to borrow from taxpayers to fill its deficits without explicit approval [1].
These funds do not appear on the government’s books as borrowing or increasing the federal budget deficit.
The Fed is appropriating taxpayer dollars on its own authority.
Need for More Transparency and Oversight
The Fed’s unique powers and loss coverage method raise oversight issues around transparency and governance [6]. The arrangement should be examined closely and addressed by Congress during the Fed’s next congressional testimony.
Sources: [1] The Hill [2] CNBC [3] Brookings Institution [4] Wall Street Journal [5] Central Bank annual reports [6] American Enterprise Institute
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