The Crisis at the Fed That No One Talks About

Of all the issues facing the Federal Reserve’s new chairman, Kevin Warsh, one that gets little public attention is the financial condition of the Fed itself. In addition to its much-publicized roles of setting short-term interest rates, which may be headed back up, and creating inflation, which is already too high, the Fed is a giant financial enterprise. It has total assets of $6.9 trillion as of March 31 combined with negative real capital. The Fed has lost hundreds of billions of dollars due to its huge interest rate risk position. This costly risk was established under the then-chairman, Ben Bernanke, who assured Congress it would be temporary. It wasn’t. It was continued under the regimes of Janet Yellen and Jerome Powell and remains embedded in the Fed’s balance sheet today, almost 18 years after Mr. Bernanke’s original gamble.It’s waiting for Chairman Warsh. The interest rate risk position is fundamentally simple. It consists of making long-term, fixed rate investments financed by floating rate funding: invest long, borrow short. It closely resembles the risk of a typical 1980s savings and loan. Because it took this risk, the Fed reported large net losses for the three calendar years 2023, 2024, and 2025, with the losses totaling the egregious sum of $211 billion. This is more than four times the Fed’s total book capital of $46 billion, which means that its capital is gone, even though the Fed refuses to show any reduction in the capital on its financial statements. The Fed argues that it can on its own decide on a special accounting treatment for itself, different from everybody else, which it would never allow its regulated banks to follow.In addition to the annual operating losses, the Fed has suffered as of March 31 mark-to-market losses of $857 billion. The Treasury securities the Fed owns are worth on the market $546 billion less than it paid for them. Its mortgage-backed securities are worth $311 billion less than it paid. The operating losses and mark-to-market losses together add up to more than $1 trillion and are 23 times the Fed’s reported book capital. The Fed has often claimed that no one should worry about its enormous losses, because it wasn’t set up to be a “profit maximizer.” However, the Fed most certainly was set up to make profits for the government. It forks over almost all its profits, which it always has had historically, to the Treasury. When it makes losses instead, payments don’t go to the Treasury, so the federal deficit and the national debt grow correspondingly bigger. The Fed’s losses are the Treasury’s and taxpayers’ losses.The owners of the Fed’s stock should also care about its losses. All $39.7 billion of the Fed’s paid-in capital is owned by private banks. Under a little-known provision of the Federal Reserve Act, they are liable to be assessed up to twice their investment in the stock to offset losses. This is disclosed in the Fed’s financial statements, although pretty well buried down in the footnotes.The Fed could reduce its interest rate risk by selling some of its long-term Treasury securities and mortgage-backed securities. If it did, though, the mark-to-market losses would become permanent cash losses. The Fed could no longer claim they were only “paper losses.” On top of that, serious Fed selling would push long-term Treasury and mortgage interest rates higher: Not a political winner.In the first quarter of 2026, the Fed reported a modest profit of $1.4 billion. Does this mean its profitability and interest rate risk problems are over? It doesn’t. My estimate is that the Fed has — on a net basis — about $2.5 trillion in long-term assets funded short. The bond market is now expecting short-term interest rates to rise again this year. If they do, it would cost the Fed $25 billion or so per year for a 1 percent rise in rates.Moreover, the profit the Fed reported for the first quarter was only possible because the Fed is being heavily subsidized by the Treasury. To do this, the Treasury holds huge interest-free deposits at the Fed — $893 billion of them on March 31. At current interest rates, these give the Fed an additional profit of $33 billion per year, while increasing the Treasury’s deficit for the year and increasing the national debt by the same $33 billion.Why doesn’t the Fed pay the Treasury, and thus the taxpayers, the same interest rate on deposits that it pays the private banks? Obviously, it should, and Congress needs to fix this. When we subtract the Treasury’s generous subsidy, the central bank is still running a significant loss, which will grow larger if short-term interest rates rise again.

The Crisis at the Fed That No One Talks About

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