Things Are So Bad Even the Fed Lost $100 Billion

Readers know that the financial system is in a slow-motion meltdown. Commercial real estate values are crashing, and the associated loans are going into default. Credit cards are maxed out and borrowers are being punished with 20% or even 30% interest rates (that will double the outstanding balance in three years if you don’t pay it off).

There’s a global dollar shortage, which explains why China is dumping U.S. Treasury securities (to get cash) and why the euro, yen, yuan, and sterling are all going down against the dollar. Investors are bracing for Stage Two of the banking crisis (Stage One consisted of the failures of Silvergate, Silicon Valley, Signature, Credit Suisse, and First Republic from March 9 to May 1, 2023).

There are plenty of other indicators out there that show expectations of a sharp recession and global financial crisis. Can things get any worse? Actually, yes.

This story reveals that not only are banks and consumers losing money, but the Federal Reserve System is losing money. The Fed has recently lost over $100 billion to be exact.

How does this happen? The Fed may be a central bank, but it’s still a bank with assets and liabilities like any other. The Fed makes money from interest payments on the U.S. Treasury securities it holds. It pays money in the form of interest on excess reserves (IOER) that are deposited with the Fed by the big banks.

The Treasury yield curve is inverted right now. This means that interest rates on short-term instruments (such as IOER) are actually higher than interest rates on longer-term instruments (such as Treasury notes). This negative interest rate spread is even more extreme when the U.S. Treasury notes held were issued in 2021 or 2022 when rates were much lower than they are today.

When you pay about 5% on your liabilities (IOER) and you only earn about 3% on your assets (Treasury notes) and you multiply that by a $5 trillion balance sheet, you can see the problem.

In fact, analysts estimate that Fed may lose $200 billion next year as the problem persists because the Fed has offered to lend money against any U.S. Treasury notes held by member banks at par value even when the notes are only worth 70% of par.

This is not happening in isolation. The Fed is required to remit its profits to the U.S. Treasury. When the profits turn into losses (as they have), this means the Treasury is losing its distributions from the Fed, which makes the U.S. budget deficit even worse.

It looks like hard times all around, but it’s especially hard when you realize the Fed and Treasury are among the big losers in this meltdown.

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