The US Federal Reserve’s $8.3 trillion bond portfolio lost $1.2 trillion.
Has the Fed failed?
In its bond portfolio, the U.S. central bank makes payments to commercial banks through reverse repurchase agreements (commonly known as reverse repurchase or RRP), resulting in losses.
If you think SVB is bad…the Fed faces about $1.2 trillion in unrealized losses in its $8.3 trillion bond portfolio.
The Fed pays commercial banks in dollars through reverse repos, losing money every day. pic.twitter.com/qBMTq7mR3E
– Wall Street Silver (@WallStreetSilv) March 13, 2023
A reverse repo is an agreement in which a central bank (in this case, the Federal Reserve) sells securities (i.e. government bonds) to commercial banks and agrees to buy them back later at a higher price. This allows the Fed to inject liquidity into the market, but doing so is more expensive due to high interest rates.
Investors and financial experts have grown increasingly concerned about news that the central bank has lost money following a shift in monetary policy.
The Fed’s bond portfolio was part of the quantitative easing program following the 2008-2009 global financial crisis. The Fed’s idea is to buy government and mortgage-backed securities (MBS) to keep interest rates low and stimulate economic growth. This works to an extent, but the downside is that the Fed now holds a lot of bonds that have been depreciated by the rise in the funds rate.
Their losses appear to have been worse after banks such as Silicon Valley Bank, which used customer deposits to buy government securities, collapsed. When customers demanded refunds, banks had to sell bonds at a discount, causing losses. To keep SVB’s depositors intact, the US government has to step in to buy such bonds at face value (reverse repos), meaning the Fed ends up holding them and taking a loss.
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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 financial markets. Critics point to the moral hazard behind bailing out insolvent institutions, which encourages risk-taking and can lead to a lack of financial discipline.
Ken Griffin, founder of hedge fund Citadel, has criticized the government’s decision to bail out Silicon Valley bank depositors, saying it shows US capitalism is “collapsing before our eyes”. He argues that financial discipline has been lost and that the government should not intervene to protect all savers, even those with balances above federally insured limits.
Against this backdrop, the price of Bitcoin rallied to reach new Q1 2023 highs above $26,000.
Bitcoin Price March 14 | Source: BTCUSDT on Binance, TradingView
Will there be a solution?
Some experts believe that the Fed’s bond portfolio is not as bad as it looks. Bonds are typically held to maturity, meaning that unrealized gains or losses disappear when the bond is called.
So losses matter only when the Fed needs to sell bonds for liquidity. So, like any bondholder, the Fed loses more on inflation than anything else because they have to hold to maturity.
Featured image from Federal Reserve, chart via TradingView
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