Bankrupt Federal Reserve to need Taxpayer Bailout

Written By: The WealthCycles Staff

The Federal Reserve is blatantly bankrupt, when the price a truly free market would charge to loan money is taken into consideration.

If you think interest rates could rise even 1% eventually, the loss on the price of the extreme amount of bonds held by the Fed would wipe out its $54,730,000 current net worth three times over. Then what?

Well, thanks to a January 6, 2011, accounting change, the Fed would then operate with negative equity, or in bankruptcy, and would stop sending excess income back to the U.S. Treasury. A Bank of America strategist and former New York Fed staffer says, “The timing of the change is not coincidental, as politicians and market participants alike have expressed concerns… about the possibility of Fed 'insolvency' in a scenario where interest rates rise significantly.”

The time will come when a decision will have to be made whether the Fed will either be recapitalized by taxpayers or allowed to fail, as faith is lost—slowly at first, then very, very quickly.

We are not the first to report on the issue of Fed insolvency, but logically it only makes sense—buy up 33% of all U.S. mortgages by year-end and more than 29% of the entire U.S. Treasury paper market at 30-year high prices, and what does one expect?

Five Fed officials look at the issue in a recent paper predicting that the income remitted to the U.S. Treasury will “likely… fall to zero.” The group highlights two risks specifically, that the Fed will:

1.    Have to sell bonds at a loss.
2.    Incur greater costs, incentivizing banks to continue storing excess reserves with the Fed by raising the rate of interest the Fed pays.

The Wall Street Journal wrote today regarding this very issue, reporting that “officials are confident [the Fed] could continue to operate… even with large losses.”

Of course there may be a “ceremonial rate rise,” to quote J. Kyle Bass, founder and principal of Hayman Capital Management, L.P., a Dallas-based hedge fund,with a few securities sold. That has happened so far throughout the great financial crisis, with accompanying breaks in printing. But there will never again exist “normal monetary policy,” or any real exit from the debt-inflation spiral.

The popular talk of exit is all about what billionaire investment expert and fund manager Eric Sprott rightly labeled as “sucking and blowing at the same time,” as monthly printing flow amounts to $85 billion. The purpose of the “sucking and blowing” is to try to limit the expected upside to the “inflation tells,” such as rises in oil, gold, silver, and agricultural prices.

The real deal is, if the Fed stops buying 70% of annual Treasury issuance, as it currently does, not only will a 2008 crash instantly repeat, bonds would also briskly lose value, bankrupting commercial banks, which all hold Treasuries as primary assets. The central planners are terrified at the prospect of real depression, even though deflation would ruin only the imprudent, insolvent banks and insurers—those who should fail. Alas, this hopeful deflationary posturing is false, and the only mathematically logical path forward is debt expansion, despite what will seem to be constant media and official channel stories to the contrary.

Mike Maloney’s Guide To Investing in Gold & Silver reminds us of the nature of this constitutionally illegal, debt-based currency monopoly:

Since the Fed opened for business in 1914, the currency of the United States (the U.S. dollar) has been borrowed into existence from a private bank (the Fed). The reason I say "borrowed" into existence is because every single dollar the Fed has ever created is owed back to that bank, with interest. The Fed creates all currency, not the U.S. government, and lends it out to the U.S. government and private institutions—with interest. Now you may be asking yourself; "If we pay back all the currency that was borrowed into existence, but we still owe the interest, where do we get the currency to pay the interest?" Answer: We have to borrow it into existence. This is one reason why the national debt keeps expanding. It can never be paid off. It is mathematically impossible.

Okay, so we are back to understanding why the Fed’s fiat, co-opted dollar has been in an 80-year bear market against gold (the U.S. $20 coin was an ounce of gold 80 years ago).

But what of the Fed bankruptcy? How negative could its capital get? Well, we know they are loading up on long-term bonds, and, as a result, Stone & McCarthy Research Associates measured risk to the Fed’s portfolio by saying it “translates to an average price decrease of ~7.65% for each percentage point increase in all yields.”

A quick back-of-the-napkin calculation would start with the Fed’s capital, $54,730,000 and then subtract losses in value of the Fed’s $2.24673 trillion portfolio. If rates rise 32bps [basis points], or merely one-third of 1%, the bonds lose an average of 2.448%, or $55 billion. Bankrupt.

Of course there is income on the portfolio that will increase capital a bit from here, and additionally no losses are realized until the Fed actually sells the bonds at a loss. The Fed’s research paper projects its capital to fall to zero by 2017 (see below), assuming $1 trillion in printing for 2013.

Federal Reserve Treasury Remittances

It will happen faster than this, as Bank of America predicts the Fed’s balance sheet growing to $5 trillion by end-2014.

"Fed ownership across the 6y-30y portion Treasury curve is likely to reach about 50% by end of 2013, and an average of 65% by end of 2014."

At the end of 2014, if rates were to rise 1%, the Fed would be in the hole by $500 billion, just as a 4% rise, back to long-term average interest rates, would mean the Fed would be $2 trillion underwater. Now that would be a big bailout, should the decision be made to recapitalize the Fed as an alternative to risking a loss in confidence in the currency it issues as its liability. Of course, the other even more massive bailout waiting to happen is the onboarding of $600 trillion-and-growing in derivative risk to a few counterparties, namely CME Group and ICE (International Currency Exchange). When a link again breaks (see graphic below) as it did in 2008, these financial institutions will be bailed out to prevent systemic failure as we (and the International Monetary Fund) explained.

2009 IMF $600 Trillion in Derivative Network Map

The final reason the Fed will never exit (besides the fact that an exit would mean committing monetary system hari-kari) is that by the end of this year, printing thus far will account for 25% of U.S. gross domestic product (GDP). So if the Fed were to ever reverse the flow, 25% of U.S. GDP would be wiped out. Also in today’s news, U.S. nominal GDP “growth” just collapsed from 3.1% to -0.1% from third to fourth quarter 2012, and the two-day Fed committee meeting concluded today with “increas[ing] a bit” comments, as Bernanke has previously hinted.

The Committee continues to see downside risks to the economic outlook.
If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate.

Once the Fed gets to the point where it has monetized (by printing and buying) the bond market, it will move on to other assets, just as the Bank of Japan and the European Central Bank have. All will work together to “buy” bad assets, struggling to avoid at all costs deflation, the healthy, natural market force by which falling asset values destroy those who are already insolvent and who are engaged in gross misallocation of resources.

The correlation implied prices for oil and gold, should inflation reach $5 trillion, are shown below, courtesy of Zerohedge:

Correlation Implied Oil and Gold at $5trillion Fed balance sheet

While the above is not a scenario where the value of the gold rises to cover the supply of currency and credit outstanding (see 1934, 1980), it may be a picture of what comes in that interim period before that final, inevitable loss of confidence occurs, as it has time and time again throughout history—even in this young country, we must remember, the Fed is our third central bank!

The loss of faith in a currency has happened more than just a few times here in the U.S. As Thomas Paine wrote in 1786, well before the national money was illegally relinquished to a central bank:

As to the romantic, if not hypocritical, tale that a virtuous people need no gold and silver, and that paper will do as well, it requires no other contradiction than the experience we have seen.
Money, when considered as the fruit of many years' industry, as the reward of labor, sweat and toil, as the widow's dowry and children's portion, and as the means of procuring the necessaries and alleviating the afflictions of life, and making old age a scene of rest, has something in it sacred that is not to be sported with, or trusted to the airy bubble of paper currency.
If anything had or could have a value equal to gold and silver, it would require no tender law.

As for our calculation of the dollar price of gold that would value of all the U.S. Treasury’s gold equal to the supply of currency and credit, fully backing it, just as has happened already twice in the U.S. alone?

$10,000.

And what would this number be if the $85 billion monthly rate of printing continues at an unchanged pace until year-end 2015?

$22,000.

testiomials The time will come when a decision will have to be made whether the Fed will either be recapitalized by taxpayers or allowed to fail, as faith is lost—slowly at first, then very, very quickly.”

Related Content