Will the Fed Need a Bailout? Nonsense!
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I'll say it bluntly: This is nonsense. The logic goes that as interest rates rise, the value of the bonds on the Fed's balance sheet lose value and the central bank will be bankrupt—requiring the taxpayers to bail it out. This is wrong on many different levels.
First: banks in general don't have to mark-to-market. Most of their assets are held to maturity and a loss does not need to be recognized unless the borrower defaults. The Fed is no regular bank: It is the buyer of last resort. It can increase its balance sheet infinitely and hold assets indefinitely. It would only take a loss if it decided, irrationally, to sell the assets. Clearly, the Fed is not run by irrational people who would shoot themselves in the foot. The most likely scenario is that it will hold the assets until maturity and let them run off gradually.
Second: if the rates rise, the government may find itself needing a bailout from the Fed—not the other way around. Should that happen, the Fed will have to increase its balance sheet by buying treasuries, not sell them. Doing so, of course, would reduce rates, making the Fed's “equity” look better, if that was ever an issue.
Third: let's assume, as irrational as it may be, that the Fed does indeed need a bailout. The article assumes that bailout money will have to come from taxpayers. But taxpayers don’t send money to the Fed. Any taxpayer money would come through the Treasury. The Treasury, normally, has relatively little cash on hand. It is funded by taxes paid or from borrowing (selling bonds/notes/bills.)
If it decides to borrow to bail out the Fed, it has to deal with Congress and the debt ceiling first. Then it has to increase their already high borrowing rates and put even more upward pressure on rates. If higher taxes are needed, the Treasury cannot just raise the tax rates or impose new taxes. It has to ask the President to introduce a bill in Congress proposing higher taxes. Needless to say, that would be a non-starter. So the idea of having the taxpayers bail out the Fed is impossible because the Treasury is in a box and the Congress is an immovable obstacle.
Fourth: even if, under duress, Congress approved additional taxes or borrowing, either action would kill the economy—prompting the Fed to reinstate another program of asset purchases (QE). Such an action would be ironic and self-defeating as the Fed would have to pay more for the same assets that it had previously sold at a loss. Fed’s loss would, of course, be the gain of the counterparties: most likely the big banks and asset managers.
–Robert Andriano is the Chief Investment Manager at Pure Investment Advisers, a boutique wealth management firm. For more info visit www.pureinv.com
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