The US Fed is Sitting On A $1.2 Trillion Loss On Its Bond Portfolio

The United States Federal Reserve (Fed) is sitting on a $1.2 trillion loss on its $8.3 trillion bond portfolio.

Is The FED Failing?

Out of their bond portfolio, the United States central bank is losing money by paying commercial banks via reverse repurchase agreements, popularly known as reverse repos or RRPs. 

Reverse repos are agreements where the central bank, in this case, the Fed, sells securities, that is, government bonds, to commercial banks and agrees to repurchase them later at a higher price. This allows the Fed to inject liquidity into the market, but this has been coming at a higher cost due to high-interest rates.

With news showing that the central bank is hemorrhaging funds after a shift in its monetary policy, there is a growing concern among investors and financial experts. 

The Fed’s bond portfolio is part of its quantitative easing program following the 2008-2009 global financial crisis. The idea was for the Fed to buy government and mortgage-backed securities (MBS) to keep interest rates low and stimulate economic growth. This worked to some extent, but the downside is that the Fed is now sitting on many bonds that are losing value on rising fund rates.

Their loss appears worse following the collapse of banks like Silicon Valley Bank that use customer deposits to buy government securities. When customers request their money back, the banks must sell the bonds at a discount, causing losses. To make depositors of SVB whole, the US government has to step in to acquire such bonds at face value (reverse repo), which means that the Fed ends up holding these bonds and their losses.

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The situation has raised concerns about the effectiveness of the Fed’s monetary policy and the impact of government intervention in the financial markets. Critics have pointed out the moral hazards behind providing bailouts to failing institutions, which encourages risky behavior and can lead to a lack of financial discipline. 

The founder of hedge fund Citadel, Ken Griffin, has criticized the government’s decision to bail out depositors of Silicon Valley Bank, saying it shows that American capitalism is “breaking down before our eyes.” He believes there has been a loss of financial discipline and that the government should not have intervened to protect all depositors, even those with balances above the federal insurance limit.

At the back of this, Bitcoin prices are rallying, reaching new Q1 2023 highs above $26,000.

Will There Be A Resolution?

Some experts argue that the Fed’s bond portfolio situation is not as dire as it seems. Bonds are typically held to maturity, which means that unrealized gains or losses disappear when the bonds are redeemed.

Therefore, the losses only matter if the Fed needs to sell the bonds for liquidity. Thus, like any bondholder, the Fed is losing to inflation more than anything else because they have to hold to maturity.