Among Federal Reserve officials and many economists, it is fashionable to argue that any losses the Federal Reserve should suffer, no matter how large, will have no operational consequence.
Is this true? If so, how does the Fed account for its losses and stay solvent? And who ends up paying for these losses? As the Fed executes its strategy to reign in run-away inflation, the answers to these questions take center stage as the Fed has already experienced mark-to-market losses of epic proportions and will soon post large operating losses, something it has never faced in its 108-year history.
We estimate that, between December 31, 2021 and the end of May 31, 2022, the Federal Reserve lost $540 billion in market value on its huge portfolio of investments in Treasury bonds and mortgage securities. To put this loss in perspective, $540 billion is equivalent to 60 percent of the value of the Federal Reserve System’s entire asset holdings on September 1, 2008, just prior to the onset of the financial crisis. $540 billion is more than 13 times the Federal Reserve System’s recently reported consolidated capital of $41 billion meaning that the market value of the Fed’s outstanding liabilities—primarily member bank reserves and Federal Reserve notes—exceed the market value of the assets the Fed owns by about half a trillion dollars. As interest rates go higher, this loss increases. Moreover, if the Fed’s inflation-fighting campaign eventually requires short-term interest rates to rise above 2.7 percent, we project the Federal Reserve will experience net operating losses, in addition to its mark-to-market losses.
Unlike banks and other financial institutions, no matter how big the losses it may face and how negative its true capital position, the Federal Reserve will not fail. But if losses, however large, can’t end the Fed, who pays for these losses? Will the Fed’s shareholders be hit in some fashion or will the losses be monetized and contribute to spiraling inflation? Should member banks be paid interest when the interest payments cause Federal Reserve losses? In recent years, questions like these have been irrelevant because the Fed has made very large profits. But this year is different. …
Source: Who Owns Federal Reserve Losses?