(Mike Maharrey, Money Metals News Service) The Federal Reserve booked $19.9 billion in operating losses in the third quarter.
Keep in mind that Fed losses ultimately become your losses. The taxpayer is on the hook for the central bank’s shortcomings.
Fed losses in the last quarter were 35 percent lower than in Q3 2023, but up from just over $16 billion in Q2.
The Fed has been bleeding red ink since Q4 2022, with total losses amounting to over $200 billion.
Why is the Fed Hemorrhaging Money?
The central bank’s own rate hikes are squeezing its bottom line. Its financial condition offers a glimpse behind the curtain into the unseen consequences of its attempt to ratchet down the price inflation it created with quantitative easing (QE) and artificially low interest rates since the 2008 Financial crises, including the monetary malfeasance of the pandemic era.
The Federal Reserve assures us that these massive paper losses don’t have any effect on its operation and won’t hinder its monetary policy.
That’s because the central bank writes its own rules. It can literally chart losses indefinitely. The U.S. Treasury bears the brunt of the central bank’s poor performance and ultimately passes those losses on to the taxpayer.
Why Is the Fed Losing Money?
As mentioned, Fed losses are the result of its own monetary policy. As rates go up, the central bank must pay more interest to banks that park funds there. But the interest income earned by Treasury bonds and mortgage-backed securities doesn’t climb as quickly. Meanwhile, the Fed has been shrinking its balance sheet as part of its inflation-fighting strategy. That means fewer assets generating interest income.
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.”
It’s also interesting to note that, like many commercial banks, the Fed has substantial unrealized losses. If you mark all the bonds held by the Fed to market value, the loss on paper stands at around $818 billion.
That’s down from just over $1 trillion at the end of Q2, thanks to a drop in long-term yields earlier this year. But yields have climbed again in recent weeks despite Fed rate cuts, and unrealized losses may cross that $1 trillion threshold by the end of the year.
Unrealized losses were the catalyst for the banking crisis in the spring of 2023.
WolfStreet offered a good explanation of how banks got into this situation:
“During the pandemic money-printing era, banks, flush with cash from depositors, loaded up on securities to put this cash to work, and they loaded up primarily on longer-term securities because they still had a yield visibly above zero, unlike short-term Treasury bills which were yielding zero or close to zero and sometimes below zero at the time. During that time, banks’ securities holdings soared by $2.5 trillion, or by 57 percent, to $6.2 trillion at the peak in Q1 2022.”
In other words, the Federal Reserve incentivized the bond-buying spree even as it was loading up on bonds via QE.
Why Are Taxpayers on the Hook for Federal Reserve Losses?
When it comes to the Fed, losses don’t matter – at least not to the central bankers running the show.
While a normal bank losing billions every quarter would be in big trouble, central bankers at the Fed can rest easy. It doesn’t matter at all. They can run losses from now until the end of time, and things will go on business as usual.
But somebody feels the pain.
That somebody is Uncle Sam.
And when Uncle Sam feels pain, we the people feel pain.
That’s because we will ultimately suffer because we (the taxpayers) are going to foot the bill.
Under the Federal Reserve charter, the central bank remits net operating profits to the U.S. Treasury. This 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 payday. To date, the negative balance due to the Treasury Department sits at $210 billion.
That means the feds ran even bigger budget deficits than they would have thanks to the Federal Reserve losing money.
And who pays for federal budget deficits?
Taxpayers.
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 eventually prints money to monetize the debt.
Meanwhile, it’s tea and crumpets over at the Eccles Building.
Typically, managers are forced to take drastic measures when their companies suffer big losses. They 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.
And therein lies the rub.
The reason the Federal Reserve can get away with this financial malfeasance is because they get to make up their own accounting rules.
You read that correctly. The central bank operates under its own special rules.
Imagine if you got to make up your own accounting rules when calculating your taxes. I bet your taxes wouldn’t be very high.
Well, you’ll be unsurprised to learn that the rules for the Fed work to its advantage.
According to its own special made-up accounting rules, a net loss at the Fed magically transforms into a “deferred asset.”
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.
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.”
In an article published by the Mises Wire last year, Alex Pollock noted that without this accounting trick, the Fed would have negative capital.
Here are the combined Fed’s correct capital accounts as of June 30, based on Generally Accepted Accounting Principles. They result in a capital of negative $32 billion:
- Paid-in capital: $36 billion
- Retained earnings: $68 billion
- Total capital: $32 billion
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.
According to an analysis by the St. Louis Fed in November 2023, it won’t likely occur until 2027. An independent analyst told Reuters the life of this mythical “deferred asset” could extend into 2028.
The bottom line is, however long the Fed continues to lose money and during the time it pays down its “deferred asset,” the federal government will experience a reduction in revenue, resulting in budget deficits higher than they otherwise would have been.
A revenue cut 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 MoneyMetals.com 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.
