The Fourteenth Banker Blog

December 13, 2010

Why Would The AEI Say Today the Federal Reserve Close To Insolvent?

Filed under: Running Commentary — thefourteenthbanker @ 3:10 PM

I was listening today to several American Enterprise Institute fellows on C-Span.  They were discussing the recent revelations about the Federal Reserve programs and under what conditions the Federal Reserve might be considered insolvent.  Isn’t it remarkable that such a conversation would even take place?  The discussion was theoretical in that it is an accounting question. The Federal Reserve does not have publicly traded stock to serve as a barometer of its health. It does not have debt rated by anybody to help people understand the strength of it’s balance sheet (BS).

We do however know something about its assets and its financial statements are public. The speakers basically had two points to make in the segments I listened to.

First, the Fed does not mark its holdings to market.  We do not really know what they are worth today or at a future point in time.  Perhaps these holdings are not so far underwater on a market value basis to make the Fed insolvent if marked to market today. In any case, the incestuous relationship with the rest of USG means that the cross guarantees of Fannie, Freddie, and others protects the Fed’s assets to some extent. Of course, those guarantees are dependent on the borrowing ability of the US Treasury, which these days requires the monetization of debt by the Fed, the largest holder of Treasury debt in the world. So that all sounds pretty good.

The second point is that in taking on this TRILLION plus in MBS, the Fed has taken on a huge tail risk in that should interest rates rise, the bonds cannot be sold for as much as they can in today’s, or three weeks ago’s bond market. The AEI estimates that a 50 bps rise in interest rates across the yield curve would make the Fed insolvent on a mark to market basis.  That may be as little as a 25 bps rise today. But so what? The Fed does not have to mark to market.

I guess my point is this. The Fed intentionally took on assets that create mark to market accounting solvency risk in a sufficient amount that a little tick up in interest rates makes those bonds worth sufficiently less to negate all the capital at the Fed. It took on a massive Fat Tail risk in these asset purchases? Why? To transfer wealth to the sellers of this paper, be they US banks, foreign banks, foreign governments. It was a transfer of wealth for the purpose of saving the financial system upon which the wealthy depend.

“Heckuva job, Bennie!”



  1. Just another case of the government eating toxic debt to save financial sector aka the rentier class. The Fed is essentially a government agency and the US government cannot “go broke” or “run out of money,” in spite of what even POTUS may assert. The US government is monetarily sovereign the last time I looked and as the monopoly issuer of its own nonconvertible floating rate currency it is not operationally constrained in its own currency. Any “insolvency” on the part of the federal government would have to be the result of an accounting regulation imposed by political choice and could be altered by political choice. Talk of US “insolvency” is just fear-mongering.

    QE 1 was a quasi-fiscal operation in that the Fed surely knew it was swallowing toxic debt that would either be marked down or default. It was a way to recapitalize the banks through the backdoor. This is one of the reasons that the Fed resisted transparency;

    This is one reason that cb “independence” should be ended. The Fed is run by the financial system for the financial system. Why is a small group of unelected and unaccountable interested technocrats give control over setting interest rates (the “price” of money) in a capitalistic system? This is a command system and the command rests with interested people. It is anti-democratic and anti-capitalistic.

    The Fed should be consolidated with Treasury and operated under political control accountable to the people at the voting booth.

    Comment by Tom Hickey — December 13, 2010 @ 3:31 PM | Reply

  2. The Fed cannot be insolvent. The Fed can issue electronic credits to any bank account it wants. These credits simply state that the Fed will clear on its own computer system any checks so presented. Hard to be insolvent when you control the bank clearing system and issue your own Fed Reserve Notes.

    This doesn’t mean, however, that what the Fed is doing is a wise thing for the folks or their future.

    Comment by Robert Garrasi — December 13, 2010 @ 4:01 PM | Reply

  3. A naive question: what constraint is there on the Federal
    Reserve’s capital, given its ability to print money?

    Comment by Curious — December 13, 2010 @ 9:49 PM | Reply

    • None that I know of at this time. Perhaps there is some political risk if enough people decide it has not used independence prudently.

      Comment by thefourteenthbanker — December 14, 2010 @ 12:13 AM | Reply

  4. Spot ON! – The FED doesn’t care about its own balance sheets, they don’t take the profits, the market players/banks do! And if they can facilitate this transfer all the better for the bankers.

    dont forget to buy silver :

    Comment by silveristhenew — December 13, 2010 @ 11:04 PM | Reply

  5. Before any discussion of the FED’s solvency, look long and hard at the AEI. What is their motive? They are, after all, neocons who took us to war in the Middle East. I for one would not consider their utterances or publications without first accessing their motives. They have proven that they are not motivated by the best interests of America.

    Comment by ella — December 14, 2010 @ 10:21 AM | Reply

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