In the shadow of the debate about inflation, key interest rates and government debt, a historically rare development is disappearing from sight. For the first time since 1915, the American Federal Reserve will suffer a loss this year. The minus is estimated at $80 billion or more. Huge book losses are not taken into account here: The bonds built up in the Fed portfolio during the quantitative easing phase have lost value as interest rates have risen. The unrealized losses are estimated at around one trillion dollars.
The operating losses alone exceed the central bank’s equity. That would mean bankruptcy for private financial institutions. But the Federal Reserve is not out for profit. She posts the cumulative losses under the item “deferred asset”, which roughly translates to “deferred asset claim”.
The ability to conduct effective monetary policy is not affected by the losses. This is the conclusion reached by central bank experts Donald Kohn and William English in an article for the Brookings think tank. This assessment, shared by most experts, leads to the wrong idea that there are no material consequences associated with the loss item.
Transfers only again in five years
The refutation of this notion can be found, for example, in the forecast for the federal budget that the independent auditors of the Congressional Budget Office (CBO) recently presented. It states: “Federal Reserve remittances will remain near zero from 2023 to 2027.” The reason given: expenditure on short-term interest exceeds interest income from the bonds. The government can only expect transfers from its central bank again in five years.
Huge sums of money are lost to the federal budget as a result. Federal Reserve Chairman Jay Powell pointed out in Wednesday’s congressional hearing that since 2010 some $1.2 trillion had been transferred to the government. That would be more than enough to fund the Biden administration’s major projects. After all, Congress has approved around 825 billion dollars for upgrading the infrastructure, the semiconductor industry and for restructuring the economy towards low-emission production.
The Federal Reserve’s huge gains, as well as its losses, are closely related to the quantitative easing program the Fed initiated in March 2020 in response to the pandemic. The bond portfolio grew from just under $4 trillion to $8.5 trillion in March 2022. The interest on bonds collected by the Fed exceeded the interest it paid on money market reserves and lending. The federal government was therefore able to look forward to record revenues of $109 billion in 2021 and $107 billion last year. After all, this corresponds to roughly a quarter of the income from corporate income tax.
The rapid slide into the red is the result of tighter monetary policy and the short-term financing of the bonds. The interest rate hike means higher financing costs for the central bank, while the interest income from the bond portfolio remains meager and constant. Given the 200-to-1 leverage ratio, high short-term interest rates turned earlier gains into heavy losses.
These are, as critic Paul Kupiec puts it, losses that hurt taxpayers for years to come. For example, they prevented tax cuts. In an essay for the Federalist Society, the economist rhetorically asks how long congressmen would tolerate the noticeable losses.
However, those more supportive of the Fed argue that the overall effect of quantitative easing remains positive, having saved the economy from a more costly slide into a deep crisis.