(Mike Maharrey, Money Metals News Service) The Federal Reserve lost $77.6 billion in 2024. And by the way, a Fed loss is ultimately your loss.

The central bank began bleeding red in late 2022. In 2023, it reported an operating loss of $114 billion.

On top of its operating loss, the Federal Reserve reported unrealized losses on its Treasury and mortgage-backed security holdings totaling $1.06 trillion. That was up from $948 billion as of the end of 2023.

Unrealized losses represent the difference between the securities’ face value when they mature and their current market value.

Why Is the Federal Reserve Bleeding Red Ink?

While most people view the central bank as an extension of the government, at its core, it is a business, and it is set up to make money.

Right now, it isn’t.

The Fed’s losses are a direct result of its rate hikes, and its financial condition offers a glimpse behind the curtain into the unseen consequences of its war on price inflation.

After insisting that price inflation was “transitory” for months, the Fed was forced to take action and begin raising interest rates in March 2022. This is the root cause of its current operating losses.

In simplest terms, as it hiked rates, the bank had to pay commercial banks more for the money they parked at the Fed. Meanwhile, its interest income remained static as the Treasuries and mortgage-backed securities on its balance sheet continued to yield lower interest income. From there, it’s a simple math problem. The bank has paid more interest to banks than it has collected on its asset portfolio.

The root of this problem goes back to the 2008 financial crisis and the Great Recession when the Fed purchased trillions in low-yielding securities during multiple rounds of quantitative easing (QE), followed by an even bigger round of bond-buying during the pandemic years. The Fed purchased these Treasuries and mortgage-backed securities during a time when interest rates were pushed artificially low by its own monetary policy.

Today, after having driven interest rates much higher over the last two years, it is paying interest at a much higher rate, however, it is still collecting lower rates of interest on the paper on its balance sheet.

The St. Louis Fed explained it this way:

“Tightening causes the net interest rate spread to fall; that is, it causes net income to fall for a constant size of the Fed’s balance sheet. This occurs because the Fed runs a maturity mismatch: It owns long-term securities and owes short-term liabilities.

“Specifically, when the Fed raises the policy rate, it is immediately paying more interest on bank reserves and reverse repos—a large portion of the Fed’s liabilities: 42.5 percent and 17.0 percent, respectively, as of Nov. 8, 2023. However, the Fed’s assets are longer-term and often pay a fixed interest rate. Therefore, when the Fed raises the policy rate, its net interest rate spread falls.”

Many commercial banks face a similar situation. In fact, this phenomenon was the root of the mini-financial crisis back in March 2022. 

The recent rate cuts afforded some relief, but the Fed still hasn’t worked its way back to the break-even point.

Fed Losses Are Your Losses

The bad news is you’re ultimately on the hook for the Fed’s business problem.

Generally, businesses experience pain when they lose money. But when the Federal Reserve loses money, the U.S. government feels the pain.

And that means you will ultimately feel the pain because you (the taxpayer) are going to foot the bill.

Under the Federal Reserve charter, the central bank remits net operating profits to the U.S. Treasury. This payday serves as an income source for the federal government and lowers the budget deficit. According to the St. Louis Fed, the central bank returned nearly $1 trillion to the U.S. Treasury between 2011 and 2021.

But when the Fed loses money, the Treasury loses its cash cow. That results in even bigger budget deficits.

Bigger deficits mean Congress either has to raise taxes to cover the shortfall, or the Treasury has to borrow even more money. Either way, taxpayers pay. They either get a bigger tax bill or they pay for the borrowing via the inflation tax when the Fed prints money to monetize the debt.

Meanwhile, it’s business as usual over at the Eccles Building.

Typically, managers have to take drastic measures when their companies suffer big losses. They generally try to slash costs. Sometimes, they lay off employees. If losses mount high enough, they might have to borrow money or sell assets. If they can’t stop the business from bleeding red ink, the company will ultimately face bankruptcy.

When the Fed loses money, the central bankers don’t have to do anything other than some creative accounting.

Their Rules Aren’t Your Rules

As George Orwell put it in Animal Farm, “All animals are equal, but some are more equal than others.”

And in the U.S., central banks get to play by different rules.

We live in a universe where the Fed gets to make its own special accounting rules, and according to its own special accounting rules, a net loss magically transforms into a “deferred asset.”

You read that right. Losses become an “asset” on the Fed’s balance sheet.

The Fed explains the “deferred asset” like this:

“[I]n the unlikely scenario in which realized losses were sufficiently large enough to result in an overall net income loss for the Reserve Banks, the Federal Reserve would still meet its financial obligations to cover operating expenses. In that case, remittances to the Treasury would be suspended, and a deferred asset would be recorded on the Federal Reserve’s balance sheet.”

Under Generally Accepted Accounting Principles, operating losses reduce a business’s reported capital or surplus. But in Fed accounting, the central bank gets to create an “asset” on its balance sheet out of thin air equal to the loss. Business goes on as usual. If losses mount, the size of this “asset” grows.

As The Hill reported, “Among other things, this accounting ‘innovation’ ensures that the Fed can keep paying dividends on its stock.”

Don’t you wish the IRS would let you use “innovative” accounting on your tax returns?

This “differed asset” has no upper limit. The Fed can keep losing money into perpetuity, and it won’t matter – at least as far as the central bank is concerned. The “asset” will just continue to grow.

Once the Fed starts making money again, it will reduce the amount of this imaginary asset. That means the U.S. Treasury won’t see another dime from the Fed until this “asset” is zeroed out.

How long will it be before the Fed starts making money again?

That remains unclear.

With the Fed easing monetary policy, it is getting closer to breaking even again. It will likely return to “profitability” this year or early next. According to Morgan Stanley, “The smaller balance sheet combined with the lower policy rate has brought the Fed out of the red.”

Even so, it will take years to pay down that deferred asset. That means it will be years before the U.S. Treasury sees a dime from the central bank.

This loss of revenue is less than ideal when Uncle Sam is already buried in over $36 trillion in debt and continues to run massive budget deficits every single month. It means the U.S. government will have to borrow even more money that the Fed will ultimately have to monetize.

And it’s less than ideal for the U.S. taxpayer how will ultimately foot the bill for higher interest expense and the price inflation created as the Fed ultimately monetizes the debt.

Mike Maharrey is a journalist and market analyst for Money Metals with over a decade of experience in precious metals. He holds a BS in accounting from the University of Kentucky and a BA in journalism from the University of South Florida.