A bad balance sheet killed Silicon Valley Bank. You know what other bank has a similar balance sheet? The Federal Reserve, the world’s largest and most influential central bank.
The Federal Reserve is in no danger of going bust. Unlike an ordinary bank, it can print money whenever it needs some. The Fed is nevertheless in an awkward spot. It is having to pay more and more on its liabilities while experiencing bigger and bigger losses on its assets — just like Silicon Valley Bank.
Ordinarily the Fed makes a profit and pays — or “remits” — the portion it doesn’t need to the Treasury. That averages about $1.5 billion each week, benefiting taxpayers by shrinking the federal budget deficit. But since late last year, the Fed has earned less than it needs to cover its operating costs and some other small expenses. This breathtaking chart shows how quickly things have gone south. As of March 15, the Fed had a “cumulative deferred asset position” of $41 billion. Once its finances turn around, it will need to earn that amount before it resumes remitting money to the Treasury, and hence to taxpayers.
To be sure, one reason this chart looks so scary is that by construction the line can never go very far above zero, while it can go way below zero. That’s because when it’s making money, the Fed pays the Treasury each week, so the surpluses never accumulate. When the bank is losing money, in contrast, the amount it will need to earn before resuming payments to the Treasury accumulates week by week.
Like Silicon Valley Bank, the Fed is getting squeezed from two sides. It’s paying higher interest rates to banks on the reserves they keep at the Fed, as well as on borrowing in what’s called the reverse repo market. But the amount it earns on the bonds it owns has not gone up much. It acquired a lot of bonds when rates were very low. Meanwhile, because rates have risen, the market value of those generally low-yielding bonds has fallen, as shown by this next chart, which I pieced together from Fed financial reports.
Luckily for the Fed, it doesn’t have to sell bonds that have lost market value, as Silicon Valley Bank did when it needed to raise money to pay depositors who wanted to withdraw their money.
Fed officials argue that it doesn’t matter that the system is losing money, while some economists contend that actually it does matter. I’ll give you both sides.
Donald Kohn, a former vice chair of the Fed, and William English, a former top staffer, wrote in June that the Fed isn’t designed to be a profit-making institution. They conceded that if the Fed kept losing money, its borrowing needs could potentially become so big that they would interfere with the conduct of monetary policy. In that case, they wrote, the Fed would need financial support from the Treasury. But they said that would happen only in the case of “truly colossal and highly improbable losses.” In reality, they said, the Fed is expected to return to profitability in coming years.
Agustín Carstens, a former governor of the Bank of Mexico, who is now general manager of the Bank for International Settlements, said in a speech last month that “sometimes losses are the price to pay” for the proper conduct of monetary policy by central banks. “Losses matter because they may inflict a bruise on public finances but a far greater injury would result from central banks neglecting their mandates in order to avoid a loss,” he said.
For good measure, here is an interchange between Fed Chair Jerome Powell and Representative French Hill, an Arkansas Republican, also in June:
HILL: So my first question is, does the Fed need a positive capital cushion in order to carry out its mission as our central bank?
POWELL: No, we don’t.
Powell told Hill that having a positive net worth is “literally not required for us to conduct the operations and do monetary policy.” He added: “We have a very thin sliver of capital, but it’s sort of symbolic.”
Now for the other side. “I mean, that’s their canned response,” Paul Kupiec, a senior fellow at the American Enterprise Institute, told me when I ran the arguments of Kohn, English, Carstens and Powell past him. He said he was disappointed that members of Congress didn’t grill Powell about the Fed’s losses when he gave his semiannual monetary policy report to both chambers this month.
Kupiec, who worked for the Fed for 10 years, said the Fed’s losses are the result of a bond-buying program — several rounds of what’s known as “quantitative easing” — that went beyond what was needed or what Congress envisioned. “Congress is really slipping when it comes to the power of the purse,” he said.
Kupiec worries that the Fed’s solution to chronic losses could be inflationary, pointing me to a 2014 paper by Marvin Goodfriend, who was an economist at Carnegie Mellon University. “A period in which the central bank is seen as having to create reserves (to pay interest on its liabilities) to stabilize the purchasing power of money will rightly unnerve and very possibly unhinge inflation expectations,” Goodfriend wrote.
Andrew Levin, an economist at Dartmouth College, told me he used to work for Kohn and English at the Fed and admires them “immensely,” but he disagrees with the bond-buying program that led to today’s Fed losses. “By early 2021, when the housing market was booming and there was lots of fiscal stimulus, the Fed should have said, ‘Is this enough now? Should we pause here?’ In fact they dug their heels in deeper,” Levin said.
In January Levin teamed up with Bill Nelson, an executive vice president and chief economist at the Bank Policy Institute, on a piece for the Mercatus Center at George Mason University. They wrote:
“It might seem extraordinary that a U.S. government institution could conduct any program that is likely to incur a cost of nearly $1 trillion to taxpayers. And it might seem equally extraordinary that such a program could be undertaken without congressional approval or even any forewarning about the magnitude of the risks. Yet that is the expected outcome of the Federal Reserve’s securities purchase program known as QE4 (its fourth round of quantitative easing).”
That estimated cost of nearly $1 trillion is based on a calculation that the Fed would have remitted about $100 billion a year to the Treasury over the coming decade if not for losses incurred from the fourth round of quantitative easing. That round began in 2020 in response to the pandemic.
After hearing from both sides, I think the Fed did go too far with its fourth round of bond-buying, which not only contributed to the spike in the inflation rate but also led to today’s losses. But I also think the Fed’s supporters are right that the losses don’t threaten the Fed’s independence or its ability to conduct monetary policy.
The Readers Write
I was delighted to read your newsletter on the contributions of older people. I was expatriated from France to Brazil for 20 years helping foreign companies there to adapt their business computing systems to Brazilian needs. I returned to France five years ago when I was 73. Here I heard, “It is time for you to retire,” or, “At your age you will not be able to endure the overloaded days of work!” My days are those of an unaccepted man in his own country because of my age without taking any account of my wide experience.
In your piece about raising the cap on earnings subject to Social Security payroll tax, you wrote, “high earners get less out of Social Security than they pay into it. Such a change would make the deal for them even worse.” Social Security is not intended to be a “deal” for high earners. They make their high earnings because of the efforts of those who earn a lot less. They should be grateful to pay a tax for those from whom they greatly benefited.
Quote of the Day
“The year 1932 was the trough of the Great Depression, and from its rotten soil was belatedly begot the new subject that today we call macroeconomics.”
— Paul Samuelson, autobiographical essay collected in “Lives of the Laureates: Twenty-Three Nobel Economists,” sixth edition, edited by Roger W. Spencer and David A. Macpherson (2014)