The Federal Reserve lost $77.6 billion in 2024.
And, by the way, a Fed loss is ultimately your loss.
The central bank began bleeding into the red at the end of 2022. In 2023, it reported an operating loss of $114 billion.
In addition to its operating loss, the Fed reported unrealized losses on its holdings of Treasury bonds and mortgage-backed securities totaling $1.06 trillion. This figure represents an increase from the $948 billion reported at the end of 2023.
Unrealized losses represent the difference between the face value of the securities when they mature and their current market value.
Why is the Fed losing money?
While most people see the central bank as an extension of the government, it is essentially a business and is set up to make money.
At the moment, it is not.
The Fed's losses are a direct result of its rate hikes, and its financial condition offers a behind-the-scenes view of the unseen consequences of its war on price inflation.
After insisting for months that price inflation was "transitory," the Fed was forced to take action and begin raising interest rates in March 2022. This is the root cause of its current operating losses.
Simply put, by raising interest rates, the bank had to pay commercial banks more for the money they deposited with the Fed. Meanwhile, its interest income remained flat, as Treasury bonds and mortgage-backed securities on its balance sheet continued to generate lower interest income. From there, it's a simple math problem: the bank has paid more interest to banks than it has collected on its asset portfolio.
The root of this problem goes back to the financial crisis of 2008 and the Great Recession, when the Fed bought trillions of dollars in low-yielding securities during multiple rounds of quantitative easing (QE), followed by an even larger round of bond buying during the pandemic years. The Fed purchased these Treasury bonds and mortgage-backed securities at a time when interest rates were kept artificially low due to its own monetary policy.
Today, after pushing interest rates much higher over the past two years, it is paying interest at a much higher rate, yet it is still charging lower interest rates on the paper on its balance sheet.
The St. Louis Fed explained it this way:
Monetary tightening causes a fall in the net interest rate spread; that is, it causes a decline in net income for a constant size of the Fed's balance sheet. This occurs because the Fed has a maturity mismatch: it holds long-term securities and owes short-term liabilities.
Specifically, when the Fed raises the policy rate, it immediately pays more interest on bank reserves and reverse repurchase agreements, a large portion of its liabilities: 42.5% and 17.0%, respectively, as of November 8, 2023. However, the Fed's assets are long-term and usually pay a fixed interest rate. Therefore, when the Fed raises the policy rate, its net interest rate spread decreases.
Many commercial banks face a similar situation. In fact, this phenomenon was at the root of the March 2022 mini-financial crisis.
Recent rate cuts provided some relief, but the Fed has yet to return to breakeven.
The Fed's losses are its losses
The bad news is that you are ultimately responsible for the Fed's business problem.
Generally, businesses suffer when they lose money. But when the Fed loses money, the U.S. government suffers.
And that means you will ultimately be the one who feels the pain because you (the taxpayer) will be the one footing the bill.
Under the Fed's charter, the central bank remits net operating earnings to the U.S. Treasury. This payment provides a source of revenue for the federal government and reduces the budget deficit. According to the St. Louis Fed, the central bank returned nearly $1 trillion to the U.S. Treasury between 2011 and 2021.
But when the Fed loses money, the Treasury loses its source of revenue. This results in even larger budget deficits.
And who pays for the federal budget deficit?
Taxpayers.
A larger deficit means Congress has to raise taxes to cover it, or the Treasury has to borrow even more money. In either case, taxpayers pay. Either they get a higher tax bill, or they pay for the borrowing through the inflationary tax when the Fed prints money to monetize the debt.
Meanwhile, it's business as usual in the Eccles building.
Managers usually have to take drastic measures when their companies suffer large losses. They usually try to cut costs. Sometimes they lay off employees. If losses accumulate sufficiently, they may be forced to borrow or sell assets. If they fail to prevent the company from making losses, the company will eventually go bankrupt.
When the Fed loses money, central bankers don't have to do anything more than a little creative accounting.
Their rules are not your rules
As George Orwell said in Animal Farm, "All animals are equal, but some are more equal than others."
And in the U.S., central banks can act by different rules.
We live in a universe where the Federal Reserve can set its own special accounting rules and, according to its own special accounting rules, a net loss is magically transformed into a "deferred asset."
You read that right. Losses become an asset on the Fed's balance sheet.
The Fed explains the "deferred asset" as follows:
In the unlikely scenario that realized losses were large enough to result in a total net loss of income for the Federal Reserve Banks, the Fed would continue to meet its financial obligations to cover operating expenses. In that event, remittances to the Treasury would be suspended and a deferred asset would be recorded on the Federal Reserve's balance sheet.
Under GAAP, operating losses reduce a company's reported capital or surplus. However, in Federal Reserve accounting, the central bank creates an "asset" on its balance sheet out of thin air equivalent to the loss. Business as usual continues. If losses grow, the size of this "asset" grows.
As The Hill reported, "Among other things, this accounting 'innovation' ensures that the Fed can continue to pay dividends on its stock."
Wouldn't you like the IRS to allow you to use "innovative" accounting on your tax returns?
This "distinct asset" has no upper limit. The Fed can keep losing money indefinitely, and it won't matter, at least to the central bank. The "asset" will simply continue to grow.
Once the Fed recovers its capital, it will reduce the amount of this imaginary asset. This means that the U.S. Treasury will not receive another penny from the Fed until this "asset" is reduced to zero.
How long will it be before the Fed starts making money again?
This is not yet clear.
With the Fed's easing of monetary policy, the Fed is approaching the break-even point. It will probably return to profitability this year or early next year. According to Morgan Stanley, "the lower balance sheet, combined with the low policy rate, has lifted the Fed out of negative territory."
Still, paying down that deferred asset will take years. That means it will be years before the U.S. Treasury gets a penny from the central bank.
This loss of revenue is unsustainable when the U.S. government is already mired in more than $36 trillion in debt and continues to run up huge budget deficits every month. This means that the U.S. government will have to borrow even more money that the Federal Reserve will eventually have to monetize.
Federal Reserve will eventually have to monetize.
And it is less than ideal for the U.S. taxpayer, who will ultimately foot the bill for the higher interest expenses and price inflation created as the Fed ends up monetizing the debt.
Mike Maharrey, Money Metals