The Federal Reserve is Insolvent

Thursday, December 24, 2009 , , , 4 Comments

Daily Reckoning:

According to its latest report, the Federal Reserve now owns over $1 trillion of mortgage-backed securities, which is 45.6% of all assets on its balance sheet. One year ago mortgage-backed securities were only 0.6% of the Federal Reserve’s total assets!

The Federal Reserve is very highly leveraged, much more than most banks. It is carrying $2.15 trillion of debt on $52.8 billion of capital, giving it a leverage of 40.8-times more debt than capital. The Federal Reserve’s mortgage-backed securities alone, represent 19-times its capital, meaning that if the true value of these assets is 5.3% less than their book value, the Federal Reserve’s capital is wiped out, effectively making it another insolvent institution.

As the Sprott Report pointed out earlier, it's not just MBSs that tip the Fed way past insolvency, it's their tricky Treasury problem. As in not being able to stop buying them.

If you did not believe we had a problem before, just stop and think about the consequences of a central bank that is leveraged 40:1 debt to capital with no signs pointing to an exit. Were this but a temporary burp in the financial system I might be inclined to say the Fed is not nearly as doomed as it appears.

But since I know better and am about 99.7% sure they still don't have a solid exit plan, it means they are, in reality, more doomed than it appears.


Jr Deputy Accountant

Some say he’s half man half fish, others say he’s more of a seventy/thirty split. Either way he’s a fishy bastard.


W.C. Varones said...

Yes, they are way underwater on both their MBSs and their Treasuries -- and they'll only become more underwater as rates rise.

They can print money to fill the holes of course. And that's exactly what they'll do if they sell securities back at a loss. But it means they don't have an exit strategy. If they sell something for less than they paid, they are draining only part of the liquidity they put into the system.

First, Merry Christmas JDA! Second, anyone who owns a money creation concession is never insolvent. That would be FRB in this case. They might take all of us down with them, but they have the printing presses. Makes cooking the books quite easy when you can create money.

Merry Christmas, MM!!

And you're right, they've got the "magic wand" but currency (sans a gold standard) is only as good as the faith on which it is printed. Considering the growing sentiment around the world that the Fed is not nearly as all-knowing and all-seeing as once believed, we might have a faith crisis on our hands.

Print print print!

What a coincidence! I am writing a post on just this topic, starting with the Fed's 12/31/08 "audited" financials. Yes, the Fed is insolvent, by $100-$400 billion! But as long as it can print Federal Reserve Notes, it will stay afloat.