A billion here and a billion there adds up to real money. When it comes to Fed losses, we are now talking about real money.
The Federal Reserve's new balance sheet report shows that in the six months that ended on March 29, it had a total operating loss of $44 billion, which is a huge amount. That's more than its capital of $42 billion, so the Federal Reserve System's capital has gone negative by $2 billion—just in time for April 1st.
This event would have shocked Fed chairmen, governors, and, we would have thought, newspaper reporters for many years. If interest rates stay anywhere near where they are now, the Fed's capital will keep going down in April and for a long time after that. In the first three months of 2023, the Fed said that it was losing $8.7 billion a month.
That would be a loss of more than $100 billion every year. Everett Dirksen's famous line about how a billion here and a billion there adds up to real money comes to mind. We are talking about big losses. These are losses from running a business. As of September 30, 2018, the Fed's mark-to-market of its assets led to an unrealized loss of $1.1 trillion.
To see the negative capital in the Fed's weekly "H.4.1" report, you do have to do some simple math in the first paragraph. The Fed's balance sheet says that its capital is $42 billion, but it breaks the most basic accounting rule (which it conveniently ignores) by not taking its operating losses as negative retained earnings and subtracting them from its capital.
Instead, it adds up the losses as a negative liability that is hard to see. The balance of this liability can be found in Section 6 of the report, which is called "Earnings remittances due to the U.S. Treasury." These are just negative retained earnings. To get the right answer, just subtract them from the stated capital.
Even though the Fed and its supporters say that negative capital and losses don't matter to a central bank, they do mean that the Fed has become a fiscal drag on the American Treasury, a cost to the taxpayers instead of a source of profits, as it was for more than a century.
This is not a good look for what is supposed to be the best central bank in the world. Did the Fed plan to lose this much money and go into the red? I don't think that's the case. But it doesn't look like the Fed ever told Congress how much money it would lose and how much it would hurt the economy.
Since 1971, Nixonian fiat money has been in place, in which the dollar is not defined by law and is not linked to gold or silver specie. This has led to $44 billion in operating losses, which is an all-time high, and they will continue.
Because of this, the Fed has become the financial equivalent of a huge savings and loan from the 1980s. About $5 trillion of the Fed's $8.7 trillion in assets are at risk. These are long-term fixed-rate investments that are paid for by floating-rate deposits and loans.
About $2.6 trillion of these investments are mortgage-backed securities, which are made from mortgages with fixed rates for 30 years. Because of this, there is a huge risk with interest rates, which led to big losses when interest rates went up. This risk with interest rates is similar to the risk that Silicon Valley Bank faced.
The Fed knew it was making the interest rate risk, but it doesn't seem to have been prepared for how big the losses would be. "Risk is the price you never thought you'd have to pay," an old banker once told me.
If short-term interest rates had stayed close to zero, the Fed would have made a lot of money instead of losing a lot. In March 2021, two years ago, the Fed was still making a lot of long-term investments and taking on a lot of risk. At the time, the Fed put out forecasts for 2022.
The Fed thought that the federal funds rate would be 0.1% in 2022, which seems crazy now but was what they thought at the time. The highest prediction from a single person was 0.6%. At the end of 2022, the fed funds rate was, as you might expect, 4.5 percent.
This is how much the Fed and the Treasury lost when the cost of its floating rate liabilities went up. So much for the Fed's vision. This is another good example of how a risky interest rate position can turn out to be much worse than you thought.
Unfortunately, the Fed's predictions and years of keeping interest rates low and buying trillions of dollars' worth of long-term bonds and mortgage securities put the entire banking system in a similar risky position.
A recent working paper from the National Bureau of Economic Research says, "Rightly, long-term fixed-rate securities and fixed-rate loans are both sources of interest rate risk for banks." Taking all of these into account, the paper says that the current mark-to-market loss of the banking system is about $2 trillion.
About $1.8 trillion is the amount of real money that all banks have. So, using the broad NBER estimates, it looks like we may have a banking system with tangible capital close to zero and a central bank with negative capital. What has the Federal Reserve done?
