Don’t Look Now — the Fed’s Bankrupt!

“In traditional layman’s terms, the Fed is bankrupt — and I don’t just mean intellectually.”

Here you have the studied conclusion of Mr. Thomas L. Hogan. This fellow holds a senior fellowship at the American Institute for Economic Research.

More from whom:

Like a private bank, the Fed maintains some level of capital as a buffer against losses. When those losses exceed the value of its capital, the Fed becomes insolvent, meaning the liabilities it owes to others are greater than the total value of the assets it holds…The Fed has experienced significant operating losses over the last six months, which have exhausted its existing capital… The most recent data show that the Fed owes the Treasury over $48 billion, which exceeds its total capital. The Fed, by common standards, is insolvent.

Kind heaven, no. Can it be?

Is the Federal Reserve Bank of the United States bankrupt — bankrupt as the honest accounting rules run?

Is the Federal Reserve Bank of the United States… broke?

They’re Starting to Worry

Alarming whispers begin to circulate. Fretful and distressed glances begin to exchange. Perspiration begins to condensate upon foreheads.

Here is another economics crackerjack — a certain Thorsten Polleit — he being chief economist with Europe’s Degussa Corp.:

Behind closed doors, the report is already making the rounds in expert circles: if you follow the rules of sound commercial accounting, the United States Federal Reserve (Fed) has lost its equity and is, as common language would have it, bankrupt.

Why is the Federal Reserve bankrupt in the common understanding?

Recall the recent run of bank deaths. What united them were their portfolio misallocations.

These portfolios were loaded through with long-term Treasury bonds. The banks purchased these “safe” bonds in a period of severely depressed interest rates.

In such a period as that bonds maintain an elevated value. They are lovely jewels. That is because bond prices and interest rates exist in antagonism… as the polar ends of the seesaw exist in antagonism.

When interest rates take to the downswing bond prices take to the upswing. When interest rates take to the upswing bond prices take to the downswing.

Thus these bonds represented beautiful portfolio assets in the period of severely depressed interest rates.

These banks expected this period of severely depressed interest rates to run and run.

Yet this period of severely depressed interest rates did not run and run.

The Fed Battles a Raging Fire That It Helped Start

As inflationary prairie fires began fanning last year the Federal Reserve unfurled the fire hoses and commenced a heroic firefighting operation.

It got good water on the flames — flames which the Federal Reserve itself helped kindle.

It undertook the most aggressive and dizzying interest rate raisings ever.

Last March the Federal Reserve’s target rate guttered along between 0.25% and 0.50%.

Today — merely 14 months later — the Federal Reserve’s target rate scrapes the sky between 5% and 5.25%.

What has been the consequence for bonds with longer-dated maturities?

The seesaw has experienced a directional swing. The bonds that were oaken assets in the period of severely depressed interest rates… turned to sawdust assets in the period of rapidly elevating interest rates.

Their prices have taken a severe chain-sawing — as have the portfolios that stabled them.

The Fed Takes a Massive Haircut to Its Portfolio

Whose portfolio stables heaps of these long-dated bonds?

That is correct — the Federal Reserve itself. The aforesaid Thomas Hogan:

In the post-pandemic period, the Fed expanded the money supply significantly to support a swift economic recovery. It did so by purchasing vast amounts of U.S. Treasury bonds and mortgage-backed securities. While at first those assets seemed like good investments, they are now a major hole in the Fed’s financial position… the Fed is paying about 3.1% per year more than it receives on its $7.88 trillion securities portfolio. That’s a loss of $244 billion per year!

Hence, the Federal Reserve is presently $48 billion in arrears to the United States Treasury.

Hence the Federal Reserve is insolvent. Hence the Federal Reserve is bankrupt.

“Ridiculous!,” comes the thundering objection. “The Fed can’t go bankrupt because, unlike normal banks, it can basically just print whatever money it needs to cover its losses. To compare the Fed to a regular bank is stupid.”

The objection is taken aboard — and the objection is sustained.

The Federal Reserve is not simply another bank. Through its manifold tricks it can make any shortage good.

The Federal Reserve will not be filing for bankruptcy under Chapter 11 of the United States Code — or under any other chapter of the United States Code.

It will not go bankrupt, certainly not in the traditional understanding.

Yet we invite you to recall your physics. We invite you to recall Sir Isaac Newton’s third law:

“For every action (force)… there is an equal and opposite reaction.”

The First Rule of Economics

The Federal Reserve can print its money, it can execute its tricks, it can “paper over” its losses.

Yet it confronts equal and opposite reactions. It confronts equal and opposite… consequences.

We cited Sir Newton’s third law of physics. We must now recall the first rule of economics:

The free lunch has no existence.

Someone must square the account. It may not be you — another man may purchase your lunch on your behalf. Yet he must reach into his pocket. He must satisfy the bill.

And if not him, somebody else must satisfy the bill.

The Federal Reserve offers no exception. It may lunch cost-free… yet it merely palms off the bill to another party.

Into whose hands does the Federal Reserve’s lunch bill go passing?

In this instance the answer is the taxpayer’s hands. Into his unwilling and undeserving hands the bill goes.

Pay up, Taxpayer!

Again we cite economist Thomas L. Hogan:

What does the Fed do when its liabilities exceed its assets? It doesn’t go into legal bankruptcy like a private company would. Instead, it creates fictitious accounts on the assets side of its balance sheet, known as “deferred assets,” to offset its increasing liabilities.

Deferred assets represent cash inflows the Fed expects in the future that will offset funds it owes to the Treasury… The Fed had already accrued $48 billion in deferred assets, and the amount is only getting larger.

The advantage to deferred assets is that the Fed can continue its normal operations without disruption…

The disadvantage is that, at a time when the Fed is already worsening the U.S. fiscal position by raising interest rates (and therefore interest payments on the federal debt), it is further robbing the Treasury of revenues by deferring them into the future. Those deferred payments, of course, must be shouldered by American taxpayers…

How do you like it? Are you hot to buy the Federal Reserve’s costly midday meal?

We hazard you are not. The bill will nonetheless come falling into your overtaxed and overlabored hands.

The Great Fiction

Again, the free lunch has no existence. Someone, somewhere, must square the account.

“Government is the great fiction,” argued classical liberal Frederic Bastiat, “through which everybody endeavors to live at the expense of everybody else.”

That is, everybody endeavors to lunch free of charge and at everybody else’s expense.

Yet justice compels us to present the bill to the fellow who munches the meal.

In this instance… justice compels us to present the bill to the Federal Reserve.

Alas, it will not accept the charge…

The Daily Reckoning