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Can the Fed Go Bankrupt?

Former Atlanta Fed President William Ford says, technically, yes, the Fed can go bankrupt. He argues that the Fed’s balance sheet is highly leveraged as a result of quantitative easing expanding its balance sheet. The result is that the Federal Reserve is thinly capitalized despite its having just transferred a record $80 billion in profit to the US Treasury. Ford says that this creates a situation in which the Fed would be technically insolvent on a mark-to-market basis if interest rates were to go up 1%.

My take: there is certainly a ‘political’ element to this analysis, namely a desire to rein in the Federal Reserve. But, clearly, the side effect of the Fed’s extreme leverage, the opacity with which it operated during the crisis, and its having bought lower quality assets is that political forces are coming to bear which will restrict its ability to act as aggressively as I believe it will want to during the next downturn. Remember, Ford is a former Fed President. So his view has more credibility in policy circles. Note his comments regarding the lack of GAAP accounting at the Federal Reserve. This is certainly something to keep in mind regarding likely future monetary policy.

Video below.

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.

9 Comments

  1. Jo says:

    Just waiting for the lunatics at The Pragmatic Capitalist to issue a rebuttal on the monetizing comment.

  2. Jo says:

    Just waiting for the lunatics at The Pragmatic Capitalist to issue a rebuttal on the monetizing comment.

  3. Debtpocalypse says:

    “Ford says that this creates a situation in which the Fed would be technically insolvent on a mark-to-market basis if interest rates were to go up 1%.”

    Ummm… the Fed isn’t obligated to mark to market. For anything.

    So, it’s irrelevant.

  4. Debtpocalypse says:

    “Ford says that this creates a situation in which the Fed would be technically insolvent on a mark-to-market basis if interest rates were to go up 1%.”

    Ummm… the Fed isn’t obligated to mark to market. For anything.

    So, it’s irrelevant.

  5. Lee Adler says:

    If the Fed could go bankrupt it would have done so in 1982 when 100% of its portfolio was under water, some of it way under. There’s just no market risk issue here since the Fed holds its Treasuries to maturity and, over time, always expands its portfolio. As far as the issue of credit risk on the half of the trillion dollar MBS port that I figure is worthless, no problem. That’s guaranteed by you and me, the US taxpayer. The yolk’s on us. Bwa ha ha.

    Not. :(

    Russ Winter and I debated this in two recent Radio Free Wall Street podcasts. Most of it is in part 1 of each, which you can listen to for free. He kind of sprang it on me in the earlier podcast. I was mostly spitting and sputtering that I thought the idea was preposterous in the first one. I had a few more facts at my disposal in the second which I’ve listed first below.

    http://wallstreetexaminer.com/podcasts/rf122210pv.mp3

    http://wallstreetexaminer.com/podcasts/rf121510pv.mp3

    The chart with this article has some interesting data on what the SOMA looked like in the 70s and 80s. http://radiofreewallstreet.fm/?p=1072 Of course bond yields rose steadily from the late 60s through 1982, which would have effectively wiped out the Fed’s capital several times over if it was marking to market.

    Just so that there’s no misunderstanding, I am a huge critic of the Fed. I think Bernanke is delusional, and so are his sycophant cohorts on the FOMC. The courage and independent thinking of men like Hoennig and Fisher are the exception, and get them exactly nowhere. The nuts and ass kissers are in charge.

    We are all fucking doomed, sorry to say, but the Fed isn’t going to go bankrupt. The fuckers made damn sure that they put that burden on us.

    Lee Adler
    The Wall Street Examiner
    http://wallstreetexaminer.com

  6. Lee Adler says:

    If the Fed could go bankrupt it would have done so in 1982 when 100% of its portfolio was under water, some of it way under. There’s just no market risk issue here since the Fed holds its Treasuries to maturity and, over time, always expands its portfolio. As far as the issue of credit risk on the half of the trillion dollar MBS port that I figure is worthless, no problem. That’s guaranteed by you and me, the US taxpayer. The yolk’s on us. Bwa ha ha.

    Not. :(

    Russ Winter and I debated this in two recent Radio Free Wall Street podcasts. Most of it is in part 1 of each, which you can listen to for free. He kind of sprang it on me in the earlier podcast. I was mostly spitting and sputtering that I thought the idea was preposterous in the first one. I had a few more facts at my disposal in the second which I’ve listed first below.

    http://wallstreetexaminer.com/podcasts/rf122210pv.mp3

    http://wallstreetexaminer.com/podcasts/rf121510pv.mp3

    The chart with this article has some interesting data on what the SOMA looked like in the 70s and 80s. http://radiofreewallstreet.fm/?p=1072 Of course bond yields rose steadily from the late 60s through 1982, which would have effectively wiped out the Fed’s capital several times over if it was marking to market.

    Just so that there’s no misunderstanding, I am a huge critic of the Fed. I think Bernanke is delusional, and so are his sycophant cohorts on the FOMC. The courage and independent thinking of men like Hoennig and Fisher are the exception, and get them exactly nowhere. The nuts and ass kissers are in charge.

    We are all fucking doomed, sorry to say, but the Fed isn’t going to go bankrupt. The fuckers made damn sure that they put that burden on us.

    Lee Adler
    The Wall Street Examiner
    http://wallstreetexaminer.com

  7. Garyhart416 says:

    Hey Jo and Ed: Can the Fed go bankrupt? Can you run out of points at a football game?

    • Notice that Ford said the Fed would be ‘technically bankrupt’ and he was talking on a mark to market basis. Ford never once said the Fed could or would be declared insolvent. The Fed doesn’t mark to market and it doesn’t report using GAAP. Moreover, General Motors had operated with negative equity for quite some time. And finally, I should add that the Chinese central bank faced a similar situation at some point during the crisis due to losses on its holdings.

      The point is the Fed will never be declared bankrupt. If you look at the Fed as a part of the consolidated government balance sheet, a government which creates the currency in which the Fed’s debts are denominated, it’s pretty clear it will never be declared bankrupt.

      As I said in the article,

      “there is certainly a ‘political’ element to this analysis, namely a desire to rein in the Federal Reserve. But, clearly, the side effect of the Fed’s extreme leverage, the opacity with which it operated during the crisis, and its having bought lower quality assets is that political forces are coming to bear which will restrict its ability to act as aggressively as I believe it will want to during the next downturn.”

      This is a political question ONLY because the Fed is never going to go broke regardless of whether or not it is technically insolvent on a mark to market basis. But, in the court of public opinion, the concept that the Fed is now highly leveraged and carrying volatile assets on its balance sheet is very much an issue I expect to limit its operating maneuverability.

    • Gary, It’s not my role to debunk every statement made by an economic commentator I talk about here. What is relevant, however, is how these statements will affect policy and the likely outcomes going forward.

      you should also see this post:

      http://www.creditwritedowns.com/2010/10/less-policy-advocacy-and-more-policy-forecasting-at-credit-writedowns.html

      In terms of actual government operations, the Fed’s mark-to-market balance sheet is a non-sequitur. It’s like saying the government is ‘technically bankrupt’ because it has more liabilities than assets marked to market. The government creates currency and can never be bankrupted. I understand the scoreboard analogy, one that Marshall uses. It doesn’t resonate with me but sure, you can make that analogy.

      On the other hand, I think Ford is ‘right’ insofar as the Fed could operate at a negative capital level on the basis he chooses. And since this had been considered the correct way to report accounts in the private sector his argument that the Fed should not have been allowed to fall into this position makes sense to me. And it will make sense to most people. In all likelihood, with Ron Paul in control of Fed oversight in the house, these issues will be very much in the limelight. And it will not make the Fed look good, but reckless and in need of oversight. This is what I foresee happening in the next year. And I am certain the Ford analysis will very much be a part of this.

    • Gary, It’s not my role to debunk every statement made by an economic commentator I talk about here. What is relevant, however, is how these statements will affect policy and the likely outcomes going forward.

      you should also see this post:

      http://www.creditwritedowns.com/2010/10/less-policy-advocacy-and-more-policy-forecasting-at-credit-writedowns.html

      In terms of actual government operations, the Fed’s mark-to-market balance sheet is a non-sequitur. It’s like saying the government is ‘technically bankrupt’ because it has more liabilities than assets marked to market. The government creates currency and can never be bankrupted. I understand the scoreboard analogy, one that Marshall uses. It doesn’t resonate with me but sure, you can make that analogy.

      On the other hand, I think Ford is ‘right’ insofar as the Fed could operate at a negative capital level on the basis he chooses. And since this had been considered the correct way to report accounts in the private sector his argument that the Fed should not have been allowed to fall into this position makes sense to me. And it will make sense to most people. In all likelihood, with Ron Paul in control of Fed oversight in the house, these issues will be very much in the limelight. And it will not make the Fed look good, but reckless and in need of oversight. This is what I foresee happening in the next year. And I am certain the Ford analysis will very much be a part of this.

  8. Garyhart416 says:

    Hey Jo and Ed: Can the Fed go bankrupt? Can you run out of points at a football game?

    • Notice that Ford said the Fed would be ‘technically bankrupt’ and he was talking on a mark to market basis. Ford never once said the Fed could or would be declared insolvent. The Fed doesn’t mark to market and it doesn’t report using GAAP. Moreover, General Motors had operated with negative equity for quite some time. And finally, I should add that the Chinese central bank faced a similar situation at some point during the crisis due to losses on its holdings.

      The point is the Fed will never be declared bankrupt. If you look at the Fed as a part of the consolidated government balance sheet, a government which creates the currency in which the Fed’s debts are denominated, it’s pretty clear it will never be declared bankrupt.

      As I said in the article,

      “there is certainly a ‘political’ element to this analysis, namely a desire to rein in the Federal Reserve. But, clearly, the side effect of the Fed’s extreme leverage, the opacity with which it operated during the crisis, and its having bought lower quality assets is that political forces are coming to bear which will restrict its ability to act as aggressively as I believe it will want to during the next downturn.”

      This is a political question ONLY because the Fed is never going to go broke regardless of whether or not it is technically insolvent on a mark to market basis. But, in the court of public opinion, the concept that the Fed is now highly leveraged and carrying volatile assets on its balance sheet is very much an issue I expect to limit its operating maneuverability.

    • Gary, It’s not my role to debunk every statement made by an economic commentator I talk about here. What is relevant, however, is how these statements will affect policy and the likely outcomes going forward.

      you should also see this post:

      http://www.creditwritedowns.com/2010/10/less-policy-advocacy-and-more-policy-forecasting-at-credit-writedowns.html

      In terms of actual government operations, the Fed’s mark-to-market balance sheet is a non-sequitur. It’s like saying the government is ‘technically bankrupt’ because it has more liabilities than assets marked to market. The government creates currency and can never be bankrupted. I understand the scoreboard analogy, one that Marshall uses. It doesn’t resonate with me but sure, you can make that analogy.

      On the other hand, I think Ford is ‘right’ insofar as the Fed could operate at a negative capital level on the basis he chooses. And since this had been considered the correct way to report accounts in the private sector his argument that the Fed should not have been allowed to fall into this position makes sense to me. And it will make sense to most people. In all likelihood, with Ron Paul in control of Fed oversight in the house, these issues will be very much in the limelight. And it will not make the Fed look good, but reckless and in need of oversight. This is what I foresee happening in the next year. And I am certain the Ford analysis will very much be a part of this.

  9. DavidLazarusUK says:

    If the Fed is vulnerable to a 1% increase in rates then it really needs to cut its lending. It could already be insolvent because of the toxic debt that it bought at over inflated prices to save the banks. These assets might only be worth par if held to maturity, and there are no further crises. If there is another crisis then these could be worthless. Since there has been no credible reform of the financial system then it will only be a few years before we have another collapse.

    • David, as I said above, there is a difference between the Fed’s being ‘technically insolvent on a mark-to-market basis’ and ‘actually insolvent under the actual accounting guidelines used’. The Fed can always hold any assets to maturity and will never be declared insolvent. The real problem for the Fed is two-fold. One is the political problem that we are talking about here that comes from having filled up their balance sheet with dodgy assets. The second problem is in getting those assets off the balance sheet. As I recall, these assets were ‘collateral’ to the Fed for loans at favourable rate. Legitimately, these assets are not the Fed’s but the banks which received the loans.

      Read here:
      http://www.creditwritedowns.com/2009/02/talf-a-bailout-if-one-reads-the-fine-print.html

      Under the TALF, the Federal Reserve Bank of New York will provide non-recourse funding to any eligible borrower owning eligible collateral. On a fixed day each month, borrowers will be able to request up to two three-year TALF loans. Loan proceeds will be disbursed to the borrower, contingent on receipt by the New York Fed’s custodian bank (custodian) of the eligible collateral, an administrative fee, and margin, if applicable. As the loan is non-recourse, if the borrower does not repay the loan, the New York Fed will enforce its rights in the collateral and sell the collateral to a special purpose vehicle (SPV) established specifically for the purpose of managing such assets.

      No one is talking about this now, but the reality is that the fed shouldn’t even have many of these assets. The question is whether and how they will dispose of them. But it won’t have any impact on the Fed’s continuing to operate.

      • DavidLazarusUK says:

        As long as the accounting rules stay as they are then the Fed should be fine. Though some assets even held to maturity will not be worth that much and huge losses might be made. That still does not make them right. Mark-to- market was brought in after Enron, and it is been abandoned because the banks are in trouble. They are still insolvent under a mark to market calculation.

        The Fed needs to unwind its QE programs to clear its balance sheet for the next crisis which I suspect is not that far away. The debts need to be transferred back to the banks. The programs were meant to allow the banks to raise private capital. The Fed needs to assess each of the big money centre banks and work out if they could survive without Fed support and another 20% of real estate losses. Those that cannot should be taken over by the FDIC, with the Fed funding the break up. They could sell off the branch networks to smaller banks, even taking equity stakes in the smaller banks so that there will not be fund raising problems. These stakes can be sold in the future. The existing big bank shareholders will be wiped out and depositors protected. If losses are large enough then the banks bond holders get wiped out as well. That way you maintain a branch system and allow depositors to have faith in regulation. With the big banks eliminated it will allow the industry to shrink to a size that is not parasitical to the nation.

        My point about lack of a credible reform of the financial system still stands. The Fed may still be functioning but unless reform is undertaken we have not improved the situation.

  10. Anonymous says:

    If the Fed is vulnerable to a 1% increase in rates then it really needs to cut its lending. It could already be insolvent because of the toxic debt that it bought at over inflated prices to save the banks. These assets might only be worth par if held to maturity, and there are no further crises. If there is another crisis then these could be worthless. Since there has been no credible reform of the financial system then it will only be a few years before we have another collapse.

    • David, as I said above, there is a difference between the Fed’s being ‘technically insolvent on a mark-to-market basis’ and ‘actually insolvent under the actual accounting guidelines used’. The Fed can always hold any assets to maturity and will never be declared insolvent. The real problem for the Fed is two-fold. One is the political problem that we are talking about here that comes from having filled up their balance sheet with dodgy assets. The second problem is in getting those assets off the balance sheet. As I recall, these assets were ‘collateral’ to the Fed for loans at favourable rate. Legitimately, these assets are not the Fed’s but the banks which received the loans.

      Read here:
      http://www.creditwritedowns.com/2009/02/talf-a-bailout-if-one-reads-the-fine-print.html

      Under the TALF, the Federal Reserve Bank of New York will provide non-recourse funding to any eligible borrower owning eligible collateral. On a fixed day each month, borrowers will be able to request up to two three-year TALF loans. Loan proceeds will be disbursed to the borrower, contingent on receipt by the New York Fed’s custodian bank (custodian) of the eligible collateral, an administrative fee, and margin, if applicable. As the loan is non-recourse, if the borrower does not repay the loan, the New York Fed will enforce its rights in the collateral and sell the collateral to a special purpose vehicle (SPV) established specifically for the purpose of managing such assets.

      No one is talking about this now, but the reality is that the fed shouldn’t even have many of these assets. The question is whether and how they will dispose of them. But it won’t have any impact on the Fed’s continuing to operate.

      • Anonymous says:

        As long as the accounting rules stay as they are then the Fed should be fine. Though some assets even held to maturity will not be worth that much and huge losses might be made. That still does not make them right. Mark-to- market was brought in after Enron, and it is been abandoned because the banks are in trouble. They are still insolvent under a mark to market calculation.

        The Fed needs to unwind its QE programs to clear its balance sheet for the next crisis which I suspect is not that far away. The debts need to be transferred back to the banks. The programs were meant to allow the banks to raise private capital. The Fed needs to assess each of the big money centre banks and work out if they could survive without Fed support and another 20% of real estate losses. Those that cannot should be taken over by the FDIC, with the Fed funding the break up. They could sell off the branch networks to smaller banks, even taking equity stakes in the smaller banks so that there will not be fund raising problems. These stakes can be sold in the future. The existing big bank shareholders will be wiped out and depositors protected. If losses are large enough then the banks bond holders get wiped out as well. That way you maintain a branch system and allow depositors to have faith in regulation. With the big banks eliminated it will allow the industry to shrink to a size that is not parasitical to the nation.

        My point about lack of a credible reform of the financial system still stands. The Fed may still be functioning but unless reform is undertaken we have not improved the situation.

        Minsky was right about clearing out problems. Before you apply Keynesian stimulus which gets disrupted in the clear out if applied too early.