In May of this year, Paul Kupiec and I estimated that the Federal Reserve’s mark to market loss on its unprecedented portfolio of Treasury bonds and mortgage securities had grown to the staggering amount of $540 billion. Now we have the Fed’s official numbers for the end of June, which by then, it turns out, were much worse than that.
Down in the footnotes of the recently released financial statements of the combined Federal Reserve Banks for the second quarter of 2022, we find this startling disclosure: the mark to market loss on June 30 had increased to $720 billion. That’s a number to get your attention, even in these days of counting in billions, especially when compared to the Fed’s reported total capital on the same date of only $42 billion. The Fed’s mark to market or economic loss at the end of the second quarter was thus 17 times its total capital, making it deeply insolvent on a mark to market basis. (Woe to any bank supervised by the Fed which gets itself in the same situation! Oh yes, we know the Fed will earnestly insist that it is different, but that doesn’t change the fact of the market value losses.)
Since the reporting date at the end of June, interest rates have gone higher, the market value of the Fed’s massive investment portfolio has shrunk even more, and the mark to market loss has gotten even more huge. Using the price sensitivity the Fed’s portfolio displayed in the first six months of 2022, we estimate that the market value loss has during the third quarter increased by $275 billion, bringing it to about $995 billion.
The loss is $995 billion now, we guess, but if interest rates rise further toward more normal levels from their previously suppressed lows, the Fed’s mark to market loss will easily reach and exceed $1 trillion. The irony of course is that the Fed was buying heavily to build its $8.8 trillion portfolio at a market top created by its own actions. In addition, the Fed is moving toward generating operating losses, even if it never sells any of its underwater bonds and mortgage securities, because it must finance its long-term fixed rate assets with floating rate liabilities at ever-higher interest rates. These operating losses will mean the federal budget deficit will be bigger since it will lack the normal contributions from Fed profits, possibly for a long time.
In the very same eventful quarter, President Biden ordered (with dubious legality) the government not to even try to collect on hundreds of billions of dollars of defaulted student loans it had made and instead to write them off. The Congressional Budget Office estimates the cost to the budget of writing off these bad debts to be $420 billion. One must conclude that, considered as a lending program, as it was enacted to be, the federal student loan program is an utter and egregious failure. It has its own deep irony, since a decade ago the CBO claimed the program would be a big source of profits to the government.
Consider these two losses together—one in the Fed’s investing and one in making government student loans. It certainly makes one doubt the acumen of the federal government as a financial manager.
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