Jim Grant: The Federal Reserve Is Broke!

The Federal Reserve is losing billions of dollars. As financial journalist and market analyst Jim Grant put it during a recent interview on Fox Business, the Fed is actually broke.

But most people don't seem concerned about the central bank's financial condition. They are more concerned about what Donald Trump may do to the Fed if he wins the election.

Reports recently surfaced that Trump would like to significantly reshape the Federal Reserve and require monetary policy to align with administration goals. Treasury Secretary Janet Yellen called the plan an attack on our institutions similar to January 6.

Meanwhile, President Joe Biden said we will get an interest rate cut, but it will be delayed a month, implying he has some say in the matter. 

So, whatever happened to Federal Reserve “independence?”

Grant said this is nothing new.

“Biden is speaking in the long tradition of Presidents Johnson and Nixon, FDR, and Truman. I don’t think there’s much new here except the reaction, perhaps, on the part of Janet Yellen.”  

 But Grant said he does see a new trend emerging – the dependence of the Federal Reserve on the Treasury Department.

“The Fed, as we would say in the private sector, is broke.” 

Grant was referring to the massive losses suffered by the central bank in this higher interest rate environment. The Fed's operating losses ballooned to a record $114.3 billion last year. To put that in perspective, it would be the third-largest bankruptcy in American history -- just behind Lehman Brothers and Washington Mutual in 2008. 

According to Grant, current losses at the central bank total $123.6 billion.

Under the Federal Reserve charter, the central bank remits net operating profits to the U.S. Treasury. This serves as an income source for the federal government and lowers the budget deficit. But when the Fed loses money, the Treasury loses its payday. That results in even bigger budget deficits. 

In effect, the Federal Reserve has borrowed $123.6 billion from the federal government.

Although Jerome Powell didn’t go to Yellen and ask for a loan, the central bank will ultimately have to pay all of this money to the Treasury.

Here’s how it works.

When the Fed loses money, the central bankers engage in some creative accounting.

We live in a universe where the Fed makes its own special accounting rules, and according to its own special accounting rules, a net loss magically transforms into a “deferred asset.”

You read that right. Losses become an “asset” on the Fed’s balance sheet.

The Fed explained the “deferred asset” like this:

[I]n the unlikely scenario in which realized losses were sufficiently large enough to result in an overall net income loss for the Reserve Banks, the Federal Reserve would still meet its financial obligations to cover operating expenses. In that case, remittances to the Treasury would be suspended and a deferred asset would be recorded on the Federal Reserve’s balance sheet.

Under Generally Accepted Accounting Principles, operating losses reduce a business’s reported capital or surplus.

But in Fed accounting, the central bank simply creates an “asset” on its balance sheet out of thin air equal to the loss. Business goes on as usual. If losses mount, the size of this “asset” grows.

Once the Fed starts making money again, it will reduce the amount of this imaginary asset as it sends the money over to the Treasury.

So Grant is correct - the Fed is indeed billions in debt to the U.S. Treasury.

Grant also discussed monetary policy during the interview, saying the Fed “dearly wants to cut interest rates.” 

“The legacy of a dozen years of zero percent or so rates, the legacy of the era of money growing on trees, the consequence has been the enormous buildup of debt, both in business and government. And what business and government don’t need is higher rates of interest.”

On the other hand, if the central bank wants to maintain the integrity of the dollar – in other words, hold down inflation – it has to address that with higher rates.

 “So, everyone is hoping and praying for lower rates and exhaling mightily when they seem to be getting them.”

You can watch the interview HERE.

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