The Fed Going Bankrupt? Not Anymore!

There was concern that the Federal Reserve—the U.S.’s central bank, the emitor of the currency—might go bankrupt, impossible as that may sound, because of losses on the toxic assets it has on its balance sheet.

Do recall, starting in the fall of 2008 through the summer of 2009, the Fed expanded its balance sheet (id est, printed money) by about $1.7 trillion, and used that to buy roughly $900 billion worth of toxic assets off the teetering banks.

Because of this Fed buy in toxic assets, the teetering banks became the Too Big To Fail banks—

—but those toxic assets didn’t simply disappear: The wound up on the Fed’s balance sheet. And though the excedent of some of those bonds were used for QE-lite, other toxic assets blew up. Hence, the concern that the Fed might itself go bankrupt.

Ah! Ye of little faith in the Fed’s machinations! Reuters came out with a story on Friday afternoon that will get a lot more play over the coming week: Seems the Fed vewy vewy quietwy solved the pwobwem:

In its January 6 weekly report, tucked away in the body of the report and written in very technical language, the Federal Reserve revised its own accounting standards insofar as it handles losses. As per the Reuters story:

The change essentially allows the Fed to denote losses by the various regional reserve banks that make up the Fed system as a liability to the Treasury rather than a hit to its capital. It would then simply direct future profits from Fed operations toward that liability.

[ . . . ]

"Any future losses the Fed may incur will now show up as a negative liability as opposed to a reduction in Fed capital, thereby making a negative capital situation technically impossible," said Brian Smedley, a rates strategist at Bank of America-Merrill Lynch and a former New York Fed staffer.

Hence the Federal Reserve will never ever have negative capital—it will never be insolvent. 

The Reuters story goes on to say that this all is a good thing, as it allows for more transparency in the Fed’s dealings. 

Perhaps. 

But it also erodes the financial separation between the Federal Reserve and the Treasury Department. The balance sheet of the two are going to become more and more intertwined. 

In and of itself, this isn’t much of an issue—but it does create the conditions whereby further monetization of Federal government debt could be carried out without much fanfare.

Federal Reserve monetization of the Federal government debt has been going on ever since the fall of 2008: First with the original Quantitative Easing, whereby troubled banks sold toxic assets to the Fed, then turned around and used that cash to buy Treasury bonds; then with QE-lite; now with QE-2, whereby the Fed is monetizing 50% to 60% of the Federal government fiscal year 2011 deficit, depending on how you count it. 

Closer ties with the Treasury would make such monetization all the more easy. 

Which only further proves our point: The United States is a banana republic—with nukes.