Federalist Society virtual event: Cryptocurrency Regulation in the Aftermath of FTX

Hosted by the Federalist Society. Click here for more.

The collapse of FTX has intensified the debate about how cryptocurrencies should be regulated, including proposed federal legislation. With a string of cryptocurrency failures and tens of billions in losses for investors, increased regulation has become a hot topic. As Bloomberg summarized: “Crypto is squarely in the cross hairs of Washington” and “Oversight of digital assets is among the most pressing issues for US financial watchdogs.”

Should cryptocurrency firms be regulated as banks? Should cryptocurrency assets be regulated as securities or as commodities? If so, who is the right regulator? Do we need new federal legislation? With enhanced financial and risk disclosures, should cryptocurrency firms only be subject to standard commercial law and, if they fail, normal bankruptcy proceedings? These issues will be addressed by this fourth in a continuing series of cryptocurrency webinars presented by the Federalist Society’s Financial Services and E-Commerce Practice Group.

Featuring:

The Honorable Cynthia Lummis, United States Senator, Wyoming 

Jerry Loeser, Of Counsel, Winston & Strawn LLP (Retired)

Steve Lofchie, Partner, Financial Services, Fried Frank

Alex J. Pollock, Senior Fellow, Mises Institute

Moderator: J.C. Boggs, Partner, Government Advocacy and Public Policy, King & Spalding

Opening remarks:

Empire Salon | Alex Pollock & Howard Adler

Hosted by Committee for the Republic. Full video here.

The Committee for the Republic seeks to restore Congress as the exclusive custodian of the war power under the U.S. Constitution. Since the Korean War, American foreign policy has operated extra-constitutionally featuring presidential usurpation and congressional abdication. The price has been staggering—not only in the squandering of trillions of dollars and lives lost but in the annihilation of liberty and the rule law. Committee salons also explore the funding necessary to finance the wars that earmark an imperial presidency. The Federal Reserve is the rich uncle of war finance.

Central banking is a cornerstone of government power under any monetary standard. But it is a lead actor in our pure fiat currency system. The first step was taken in 1933 when President Franklin Roosevelt by executive order prohibited Americans from owning gold. The culminating step was taken in 1971 by President Nixon's severing of the last tie of the dollar to gold -- putting the world on an "elastic" paper money standard.

Alex Pollock and Howard Adler will address their new book, Surprised Again!--The Covid Crisis and the New Market Bubble. It dissects the 2020 financial panic, the massive government interventions to finance it, and the ensuing Everything Bubble and high inflation. With fiat currency in unlimited supply, the Fed was essential to financing these expansions of government. Its balance sheet ballooned by over $4 trillion in printing the dollars needed to "lend freely" into the financial crisis and to cover the staggering government deficits which ensued. The Fed performed the real first mission of every central bank: financing the government of which it is a part.

The salon will also explore the wider implications of the role of the Fed as paymaster of the American empire and enabler of our multi-trillion-dollar military-industrial-security complex. Since the Bank of England was formed in 1694 to finance King William's wars, the link of central banking to war finance has continued. The Constitution entrusts to Congress financing government operations, but Congress has surrendered responsibility to the executive branch and the central bank. The dollar as a reserve currency enables the Fed to fund the empire with foreign dollar holdings.

Opening remarks:

Have we lost an independent central bank?

In post-WW1 Germany, who caused inflation?

Explain if we are really surprised by massive financial events or not.

What are the implications long-term of manipulating interest rates?

How expensive would wars be if we weren't the reserve currency?

Broad question about the role of the Fed.

Question about the broad role of the Fed and its political involvement as well as the value of currency boards.

The Fed’s Operating Losses Become Taxpayer Losses

Published in the Federalist Society with Paul H. Kupiec.

The year 2023 is shaping up to be a financially challenging one for the Federal Reserve System. The Fed is on track to post its first annual operating loss since 1915. The annual loss will be large, perhaps $80 billion or more, and this cash loss does not count the massive unrealized mark-to-market losses on the Fed’s fixed-rate securities portfolio. An operating loss of $80 billion would, if properly accounted for, leave the Fed with negative capital of $38 billion at year-end 2023. If interest rates stay at their current level or higher, the Fed’s operating losses will impact the federal budget for several years, requiring new tax revenues to offset the continuing loss of billions of dollars in Fed’s former remittances to the U.S. Treasury.

The Federal Reserve has already confirmed a substantial operating loss for the fourth quarter of 2022. Audited figures must wait for the Fed’s annual financial statements, but a preliminary Fed report for 2022 shows a fourth quarter operating loss of over $18 billion. The losses continued in January 2023, bringing the total loss since September to $27 billion, as shown in the Fed’s February 2 H.4.1 Report. Since it raised the cost of its deposits again by raising rates on February 1, the Fed is losing at an even faster rate. If short-term interest rates increase further going forward, the operating loss will correspondingly increase. Again, these are cash losses, and do not include the Fed’s unrealized, mark-to-market loss, which it reported as $1.1 trillion as of September 30, 2022.

The Fed obviously understood its risk of loss when it financed about $5 trillion in long-term, fixed rate, low-yielding mortgage and Treasury securities with floating rate liabilities. These quantitative easing (QE) purchases were a Fed gamble. In the past, with interest rates suppressed to historically minimal levels, the short-funded investments made the Fed a profit. But these investments, so funded, created a massive Fed interest rate risk exposure that could generate mind-boggling losses if interest rates rose—as they now have.

The return of high inflation required increases in short-term interest rates, but they are only back to normal historical levels. This pushed the cost of the Fed’s floating-rate liabilities much higher than the yield the Fed earns on its fixed-rate investments. Given the Fed’s 200-to-1 leverage ratio, higher short-term rates quickly turned the Fed’s previous profits into very large losses. The financial dynamics are exactly those of a giant 1980s Savings & Loan.

To cover its current operating losses, the Fed prints new dollars as needed. In the longer run, the Fed plans to recover its accumulated operating losses by retaining its seigniorage profits in the future, when its massive interest rate mismatch will finally have rolled off. This may take a while, since the Fed reports $4 trillion in assets with more than 10 years to maturity (see H.4.1 Report, Section 2). During this time, the future seigniorage earnings that otherwise would have been remitted to the U.S. Treasury, reducing the need for federal tax revenues, will not be remitted. It turns out the Fed’s gamble carried the risk that QE might generate taxpayer costs, costs that are being realized today. The Fed’s QE gamble has turned into a buy-now pay later policy—costing taxpayers billions in 2023, 2024, and additional years to pay for its QE purchases.

The Fed’s 2023 messaging problem is to justify spending tens of billions of taxpayer dollars without getting congressional pre-approval for the costly gamble. Did the Fed explain to Congress the risk of the gamble? The Fed now tries to downplay this embarrassing predicament by arguing that it can use non-standard accounting to call its growing losses by a different name: a “deferred asset.” They are assuredly not an asset of any kind, but properly considered are a reduction in capital. The political effects of the losses are complicated by the fact that most of the Fed’s exploding interest expense is paid to banks and other regulated financial institutions.

When Congress passed legislation in 2006 authorizing the Fed to pay interest on bank reserve balances, Congress was under the impression that the Fed would pay interest on required reserves, and a much lower rate of interest—if anything at all—on bank excess reserve balances. Besides, until 2008, excess reserve balances were very small, so the Fed’s interest expense on them was expected to be negligible.

Surprise! Since 2008, in response to events unanticipated by Congress and the Fed, the Fed vastly expanded its balance sheet, funding Treasury and mortgage securities purchases using bank reserves and reverse repurchase agreements. The Fed now pays interest on $3.1 trillion in bank reserves and interest on $2.5 trillion in repo borrowings, both of which are paid at interest rates that now far exceed the yields the Fed earns on its fixed-rate securities holdings. The Fed’s interest payments accrue to banks, primary dealers, mutual funds, and other financial institutions, while a significant share of the resulting losses will now be paid by current and future taxpayers.

It was long assumed that the Fed would always make profits with a positive fiscal impact. In 2023 and going forward, the Fed will negatively impact fiscal policy—something Congress never intended. Once Congress understands the current and potential future negative fiscal impact of the Fed’s monetary policy gamble, will it agree that the ongoing billions in Fed losses are no big deal?The year 2023 is shaping up to be a financially challenging one for the Federal Reserve System. The Fed is on track to post its first annual operating loss since 1915. The annual loss will be large, perhaps $80 billion or more, and this cash loss does not count the massive unrealized mark-to-market losses on the Fed’s fixed-rate securities portfolio. An operating loss of $80 billion would, if properly accounted for, leave the Fed with negative capital of $38 billion at year-end 2023. If interest rates stay at their current level or higher, the Fed’s operating losses will impact the federal budget for several years, requiring new tax revenues to offset the continuing loss of billions of dollars in Fed’s former remittances to the U.S. Treasury.

The Federal Reserve has already confirmed a substantial operating loss for the fourth quarter of 2022. Audited figures must wait for the Fed’s annual financial statements, but a preliminary Fed report for 2022 shows a fourth quarter operating loss of over $18 billion. The losses continued in January 2023, bringing the total loss since September to $27 billion, as shown in the Fed’s February 2 H.4.1 Report. Since it raised the cost of its deposits again by raising rates on February 1, the Fed is losing at an even faster rate. If short-term interest rates increase further going forward, the operating loss will correspondingly increase. Again, these are cash losses, and do not include the Fed’s unrealized, mark-to-market loss, which it reported as $1.1 trillion as of September 30, 2022.

The Fed obviously understood its risk of loss when it financed about $5 trillion in long-term, fixed rate, low-yielding mortgage and Treasury securities with floating rate liabilities. These quantitative easing (QE) purchases were a Fed gamble. In the past, with interest rates suppressed to historically minimal levels, the short-funded investments made the Fed a profit. But these investments, so funded, created a massive Fed interest rate risk exposure that could generate mind-boggling losses if interest rates rose—as they now have.

The return of high inflation required increases in short-term interest rates, but they are only back to normal historical levels. This pushed the cost of the Fed’s floating-rate liabilities much higher than the yield the Fed earns on its fixed-rate investments. Given the Fed’s 200-to-1 leverage ratio, higher short-term rates quickly turned the Fed’s previous profits into very large losses. The financial dynamics are exactly those of a giant 1980s Savings & Loan.

To cover its current operating losses, the Fed prints new dollars as needed. In the longer run, the Fed plans to recover its accumulated operating losses by retaining its seigniorage profits in the future, when its massive interest rate mismatch will finally have rolled off. This may take a while, since the Fed reports $4 trillion in assets with more than 10 years to maturity (see H.4.1 Report, Section 2). During this time, the future seigniorage earnings that otherwise would have been remitted to the U.S. Treasury, reducing the need for federal tax revenues, will not be remitted. It turns out the Fed’s gamble carried the risk that QE might generate taxpayer costs, costs that are being realized today. The Fed’s QE gamble has turned into a buy-now pay later policy—costing taxpayers billions in 2023, 2024, and additional years to pay for its QE purchases.

The Fed’s 2023 messaging problem is to justify spending tens of billions of taxpayer dollars without getting congressional pre-approval for the costly gamble. Did the Fed explain to Congress the risk of the gamble? The Fed now tries to downplay this embarrassing predicament by arguing that it can use non-standard accounting to call its growing losses by a different name: a “deferred asset.” They are assuredly not an asset of any kind, but properly considered are a reduction in capital. The political effects of the losses are complicated by the fact that most of the Fed’s exploding interest expense is paid to banks and other regulated financial institutions.

When Congress passed legislation in 2006 authorizing the Fed to pay interest on bank reserve balances, Congress was under the impression that the Fed would pay interest on required reserves, and a much lower rate of interest—if anything at all—on bank excess reserve balances. Besides, until 2008, excess reserve balances were very small, so the Fed’s interest expense on them was expected to be negligible.

Surprise! Since 2008, in response to events unanticipated by Congress and the Fed, the Fed vastly expanded its balance sheet, funding Treasury and mortgage securities purchases using bank reserves and reverse repurchase agreements. The Fed now pays interest on $3.1 trillion in bank reserves and interest on $2.5 trillion in repo borrowings, both of which are paid at interest rates that now far exceed the yields the Fed earns on its fixed-rate securities holdings. The Fed’s interest payments accrue to banks, primary dealers, mutual funds, and other financial institutions, while a significant share of the resulting losses will now be paid by current and future taxpayers.

It was long assumed that the Fed would always make profits with a positive fiscal impact. In 2023 and going forward, the Fed will negatively impact fiscal policy—something Congress never intended. Once Congress understands the current and potential future negative fiscal impact of the Fed’s monetary policy gamble, will it agree that the ongoing billions in Fed losses are no big deal?

Letter: A piece that displayed that iron law of finance

Published in the Financial Times:

Martin Wolf’s timely opinion piece “We must tackle crisis of global debt” (January 18) displays once again an iron law of finance that “loans which cannot be paid will not be paid” — which applies to sovereign debtors as well as all others who have borrowed beyond their means.

Once we realise that this is the situation we have got ourselves into, the only question is how to divide up the losses among the parties. “Who gets to eat how much loss?” is the simple statement of what all the discussions of “debt restructuring” are about.

Mises Institute's Alex Pollock explains how to pay all of Treasury’s bills easily

From Chicago’s Morning Answer:

How to pay all of the Treasury’s bills without raising the debt limit

Published in The Hill with Paul H. Kupiec is a senior fellow at the American Enterprise Institute.

The news is filled with dire warnings of what will happen if Congress does not lift the debt ceiling and the U.S. Treasury defaults on its debt. 

Conservative House Republicans in the new Congress have promised to block any increase in the debt ceiling without an agreement to make cuts in the government’s massive deficit spending. President Biden has vowed not to negotiate and says Congress must pass a clean bill that only increases the debt ceiling. 

Unless Congress raises the debt limit, Treasury Secretary Janet Yellen estimates that the Treasury will run out of cash and be unable to pay all its bills sometime in June, triggering a default on the U.S. Treasury’s outstanding debt.

It would be ridiculous, wouldn’t it, for the Treasury to default on its debt when it owns more than half a trillion dollars worth of the most classic monetary asset there is: gold. If there is a way to convert the gold into cash in the Treasury’s bank account, then the government can pay its bills through the end of the fiscal year 2023 without an increase in the debt limit. There is a way, and it has been done multiple times in the past. All that is required is the passage of a bill that changes a few words in existing legislation — a bill that both Republicans and Democrats should support.

The Treasury owns a lot of gold: 261.5 million ounces of it, or more than 8,170 tons. The market price of gold is about $1,940 per ounce, so the Treasury’s gold is actually worth about $507 billion. Because of a law passed in 1973, the Gold Reserve Act requires the Treasury to value its gold at $42.22 per ounce — a number 50 years out of date and with no connection to reality. Gold is in fact a giant undervalued monetary asset of the Treasury. Unlike the phony idea of the Treasury issuing a trillion-dollar platinum coin, the gold owned by the U.S. Treasury is real; because of an outdated law, the Treasury just values it at an absurdly low price.

With the proposed change, the Treasury can simply issue gold certificates against the market value of its gold and deposit these certificates into its account with the Federal Reserve. The Fed will credit the Treasury’s account with an equivalent value in dollars, and the Treasury can spend the money as needed. The Treasury already has $11 billion in gold certificates deposited with the Fed. If the Treasury revalues its gold holding to current prices, we calculate that it can deposit $494 billion in new gold certificates at the Fed — creating $494 billion in spendable dollars without creating a penny of additional Treasury debt.

The Gold Reserve Act, as amended in 1973, provides that: “The Secretary [of the Treasury] may issue gold certificates against other gold held in the Treasury. The Secretary may prescribe the form and denominations of the certificates.” So the authorization to create gold certificates could not be clearer.

Then comes the words needing legislative change: “The amount of outstanding certificates may be not more than the value (for the purpose of issuing those certificates, of 42 and two-ninths dollars a fine troy ounce) of the gold held against the gold certificates.” New legislation is required to modify the Gold Reserve Act and strike “42 and two-ninths dollars” and replace it with “the current market value (as determined by the Secretary at the time of issuance).”Unless Congress raises the debt limit, Treasury Secretary Janet Yellen estimates that the Treasury will run out of cash and be unable to pay all its bills sometime in June, triggering a default on the U.S. Treasury’s outstanding debt.

It would be ridiculous, wouldn’t it, for the Treasury to default on its debt when it owns more than half a trillion dollars worth of the most classic monetary asset there is: gold. If there is a way to convert the gold into cash in the Treasury’s bank account, then the government can pay its bills through the end of the fiscal year 2023 without an increase in the debt limit. There is a way, and it has been done multiple times in the past. All that is required is the passage of a bill that changes a few words in existing legislation — a bill that both Republicans and Democrats should support.

The Treasury owns a lot of gold: 261.5 million ounces of it, or more than 8,170 tons. The market price of gold is about $1,940 per ounce, so the Treasury’s gold is actually worth about $507 billion. Because of a law passed in 1973, the Gold Reserve Act requires the Treasury to value its gold at $42.22 per ounce — a number 50 years out of date and with no connection to reality. Gold is in fact a giant undervalued monetary asset of the Treasury. Unlike the phony idea of the Treasury issuing a trillion-dollar platinum coin, the gold owned by the U.S. Treasury is real; because of an outdated law, the Treasury just values it at an absurdly low price.

With the proposed change, the Treasury can simply issue gold certificates against the market value of its gold and deposit these certificates into its account with the Federal Reserve. The Fed will credit the Treasury’s account with an equivalent value in dollars, and the Treasury can spend the money as needed. The Treasury already has $11 billion in gold certificates deposited with the Fed. If the Treasury revalues its gold holding to current prices, we calculate that it can deposit $494 billion in new gold certificates at the Fed — creating $494 billion in spendable dollars without creating a penny of additional Treasury debt.

The Gold Reserve Act, as amended in 1973, provides that: “The Secretary [of the Treasury] may issue gold certificates against other gold held in the Treasury. The Secretary may prescribe the form and denominations of the certificates.” So the authorization to create gold certificates could not be clearer.

Then comes the words needing legislative change: “The amount of outstanding certificates may be not more than the value (for the purpose of issuing those certificates, of 42 and two-ninths dollars a fine troy ounce) of the gold held against the gold certificates.” New legislation is required to modify the Gold Reserve Act and strike “42 and two-ninths dollars” and replace it with “the current market value (as determined by the Secretary at the time of issuance).”

Voila! The Treasury has $494 billion more in cash with no additional debt. The president’s budget proposed a deficit of $1.2 trillion for fiscal 2023, so the additional funds should carry the Treasury from the current June deadline to easily past the end of fiscal 2023, giving the new Republican House majority, and the Democratic Senate majority, time to negotiate, in regular order, and pass a 2024 fiscal year budget with spending cuts as well as pass a new appropriately-sized debt ceiling to facilitate government funding in fiscal 2024 and beyond.

By merely recognizing the true market value of the Treasury’s gold holdings, the intense embarrassment to the administration and Congress of a looming default by the Treasury can be completely avoided. It is indeed ironic that in a world of inflated fiat currency and massive deficit finance, simply recognizing the true value of the government’s gold holdings can keep the government solvent. There are no budgetary tricks involved. It’s been done before and can work again.

Alex J. Pollock is a senior fellow at the Mises Institute and the co-author of the new book, “Surprised Again!—The Covid Crisis and the New Market Bubble. ” Paul H. Kupiec is a senior fellow at the American Enterprise Institute.

The Fed’s quantitative easing gamble costs taxpayers billions

Published in The Hill with Paul H. Kupiec is a senior fellow at the American Enterprise Institute.

The year 2023 is shaping up to be a challenging one for the Federal Reserve System. 

The Fed is on track to post its first annual operating loss since 1915. Per our estimates, the loss will be large, perhaps $100 billion or more, and this cash loss does not count the unrealized mark-to-market losses on the Fed’s massive securities portfolio. An operating loss of $100 billion would, if properly accounted for, leave the Fed with negative capital of $58 billion at year-end 2023. 

At current interest rates, the Fed’s operating losses will impact the federal budget for years, requiring new tax revenues to offset the continuing loss of billions of dollars in the Fed’s former remittances to the U.S. Treasury.

The Federal Reserve has already confirmed a substantial operating loss for the fourth quarter of 2022. Audited figures must wait for the Fed’s annual financial statements, but a preliminary Fed report for 2022 shows a fourth-quarter operating loss of over $18 billion. The weekly Fed H.4.1 reports suggest that after December’s 50 basis point rate hike, the Fed is losing at a rate of about $2 billion a week. This weekly loss rate when annualized totals a $100 billion or more loss in 2023. If short-term interest rates increase further, operating losses will increase. Again, these are cash losses and do not include the Fed’s unrealized, mark-to-market loss, which it reported as $1.1 trillion on Sept. 30. 

The Fed obviously understood its risk of loss when it financed about $5 trillion in long-term, fixed-rate, low-yielding mortgage and Treasury securities with floating-rate liabilities. These are the net investments of non-interest-bearing liabilities — currency in circulation and Treasury deposits — thus investments financed by floating rate liabilities.

These quantitative easing purchases were a Fed gamble. With interest rates suppressed to historically minimal levels, the short-funded investments made the Fed a profit. But these investments, so funded, created a massive Fed interest rate risk exposure that could generate mind-boggling losses if interest rates rose — as they now have.

The return of high inflation required the Fed to increase short-term interest rates, which pushed the cost of the Fed’s floating-rate liabilities much higher than the yield the Fed earns on its fixed-rate investments. Given the Fed’s 200-to-1 leverage ratio, higher short-term rates quickly turned the Fed’s previous profits into very large losses. The financial dynamics are exactly those of a giant 1980s savings and loan.

To cover its current operating losses, the Fed prints new dollars as needed. In the longer run, the Fed plans to recover its accumulated operating losses by retaining its seigniorage profits (the dollars the Fed earns managing the money supply) in the future once its massive interest rate mismatch has rolled off. This may take a while since the Fed reports $4 trillion in assets with more than 10 years to maturity. During this time, future seigniorage earnings that otherwise would have been remitted to the U.S. Treasury, reducing the need for Federal tax revenues, will not be remitted. 

While not widely discussed at the time, the Fed’s quantitative easing gamble put taxpayers at risk should interest rates rise from historic lows. The gamble has now turned into a buy-now-pay-later policy — costing taxpayers billions in 2023, 2024 and perhaps additional years as new tax revenues will be required to replace the revenue losses generated by quantitative easing purchases. 

The Fed’s 2023 messaging problem is to justify spending tens of billions of taxpayer dollars without getting congressional pre-approval for the costly gamble. Did Congress understand the risk of the gamble? The Fed tries to downplay this embarrassing predicament by arguing that it can use non-standard accounting to call its growing losses something else: a “deferred asset.” The accumulated losses are assuredly not an asset but properly considered are a reduction in capital. The political fallout from these losses will be magnified by the fact that most of the Fed’s exploding interest expense is paid to banks and other regulated financial institutions.

When Congress passed legislation in 2006 authorizing the Fed to pay interest on bank reserve balances, Congress was under the impression that the Fed would pay interest on required reserves, and a much lower rate of interest — if anything at all — on bank excess reserve balances. Besides, at the time, excess reserve balances were very small, so if Fed did pay interest on excess reserves, the expense would have been negligible.  

Surprise! Since 2008, in response to events unanticipated by Congress and the Fed, the Fed vastly expanded its balance sheet, funding Treasury and mortgage securities purchases using bank reserves and reverse repurchase agreements. The Fed now pays interest on $3.1 trillion in bank reserves and interest on $2.5 trillion in repo borrowings, both of which are paid at interest rates that now far exceed the yields the Fed earns on its fixed-rate securities holdings. The Fed’s interest payments accrue to banks, primary dealers, mutual funds and other financial institutions while a significant share of the resulting losses will now be paid by current and future taxpayers.

It was long assumed that the Fed would always make profits and contribute to Federal revenues. In 2023 and going forward, the Fed will negatively impact fiscal policy — something Congress never intended. Once Congress understands the current and potential future negative fiscal impact of the Fed’s monetary policy gamble, will it agree that the looming Fed losses are no big deal? 

Alex J. Pollock is a senior fellow at the Mises Institute and the co-author of the new book, “Surprised Again! — The Covid Crisis and the New Market Bubble.” Paul H. Kupiec is a senior fellow at the American Enterprise Institute.

A “default on our debt” would be unprecedented in American history?

Published in Politifact:

Possible precedents for defaults

In a 2021 op-ed in The Hill, a political news outlet, Alex J. Pollock, a former Treasury Department official, argued that there are four precedents for U.S. defaults.

Pollock cited cases of the U.S. Treasury:

• Resorting to paper money largely not supported by gold during the Civil War in 1862;

• Redeeming gold bonds with paper money rather than gold coins during the Great Depression in 1933; 

• Not honoring silver certificates with an exchange of silver dollars in 1968; and

• Abandoning the Bretton Woods Agreement in 1971, which included a commitment to redeem dollars held by foreign governments for gold. 

…

Our Sources

Hakeem Jeffries, interview with NBC’s "Meet the Press," Jan. 8, 2023

Congressional Research Service, "Has the U.S. Government Ever ‘Defaulted’?" Dec. 8, 2016

Alex J. Pollock, "The US has never defaulted on its debt — except the four times it did," Oct. 7, 2021

How FedGov Destroyed the Housing Market

This podcast is published by the Mises Institute.

There is no real housing market in the US. Instead, an unholy trinity of Fannie/Freddie, the US Treasury, and the Federal Reserve Bank operate to distort the market at every turn and drive home prices up dramatically. Mises Institute Senior Fellow Alex Pollock, an economist and former mortgage banker, joins Jeff to describe the reality few Americans know.

Alex Pollock's new book Surprised Again: The Covid Crisis and the New Market Bubble : Mises.org/HAP377a

Alex Pollock on how the Fed became the world's biggest S&L: Mises.org/HAP377b

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"The Most Important Price of All"

Published in Law & Liberty:

In The Price of Time, Edward Chancellor has given us a colorful and provocative review of the history, theory, and profound effects of interest rates, the price that links the present and the future, which he argues is “the most important price of all.” 

The history runs from Hammurabi’s Code, which in 1750 BC was “largely concerned with the regulation of interest,” and from the first debt cancellation (which was proclaimed by a ruler in ancient Mesopotamia) all the way to our world of pure fiat currencies, the recent Everything Bubble (now deflating), cryptocurrencies (now crashing), and the effective cancellation of government debt by inflation and negative interest rates.

The intellectual and political debates run from the Old Testament to Aristotle to John Locke and John Law, to Friedrich Hayek and John Maynard Keynes, to Xi Jinping and Ben Bernanke, and many others.  

As for the vast effects of interest rates, a central theme of the book is that in recent years interest rates were held too low for too long, being kept “negative in real terms for years on end,” with resulting massive financial distortions for which central banks are culpable. 

The Effects of Low Interest Rates

Chancellor chronicles how over the centuries, many writers and politicians have favored low interest rates. They have in mind an image of the Scrooge-like lender, always a usurer lending at excessive interest, grinding down the impoverished and desperate borrower—not unlike contemporary discussions of payday lending. For example, Chancellor quotes A Discourse Upon Usury, written by an Elizabethan judge in 1572, which describes the usurer as “hel unsaciable, the sea raging, a cur dog, a blind moul, a venomus spider, and a bottomless sacke…most abominable in the sight of God and man.” Presumably, the members of the American Bankers Association and of the Independent Community Bankers of America would object to this description.

In fact, the roles of lender and borrower have often been and are in large measure today the opposite of the traditional image. This was already clear to John Locke, as Chancellor shows us. The great philosopher turned his mind in 1691 to “Some Considerations of the Lowering of Interest Rates” and “saw many disadvantages arising from a forced reduction in borrowing costs” and lower interest rates paid to lenders. For who are these lenders? Wrote Locke: “It will be a loss to Widows, Orphans, and all those who have their Estates in Money”—just as it was a loss in 2022 to the British pension funds when these funds got themselves in trouble by trying to cope with excessively low interest rates. Moreover, who would benefit from lower interest rates? Locke considered that low interest rates “will mightily increase the advantages of bankers and scriveners, and other such expert brokers … It will be a gain to the borrowing merchant.” Lower interest rates, Chancellor adds, would also benefit “an indebted aristocracy.”

In Chancellor’s summary, “Locke was the first writer to consider at length the potential damage produced by taking interest rates below their natural level.” Locke’s position in modern language includes these points:

• Financiers would benefit at the expense of ”widows and orphans”

• Wealth would be redistributed from savers to borrowers

• Too much borrowing would take place

• Asset price inflation would make the rich richer

Just so, over our recent years of too-low interest rates, ordinary people have had the purchasing power of their savings expropriated by central bank policy and leveraged speculators of various stripes made large profits from overly cheap borrowing, while debt boomed and asset prices inflated into the Everything Bubble.

The central bankers knew what they were doing with respect to asset prices. Chancellor quotes a remarkably candid statement in a Federal Open Market Committee meeting in 2004, in which, as a Federal Reserve Governor clearly put it:

[Our] policy accommodation—and the expectation that it will persist—is distorting asset prices. Most of the distortion is deliberate and a desirable effect if the stance of policy. We have attempted to lower interest rates below long-term equilibrium rates and to boost asset prices in order to stimulate demand.

That boosting asset prices was “deliberate” is correct; that it was “desirable” seems mistaken to Chancellor and to me. “The records show that the Fed had used its considerable powers to boost the housing market,” he writes (I prefer the phrase, “stoke the housing bubble”). What is worse, the Fed did it twice, and we had two housing bubbles in the brief 23 years of this century. In 2021, the Fed was inexcusably buying mortgage securities and suppressing mortgage rates while the country was experiencing a runaway house price inflation (now deflating).

In general, “Wealth bubbles occur when the interest rate is held below its natural level,” Chancellor concludes.

Bad Press

On a different note, he mentions that suppression of interest rates could lead to “Keynes’ long-held ambition for the euthanasia of the rentier,” using Keynes’ own memorable, if unpleasant, phrase. The recent long period of nearly zero interest rates, however, led to huge market gains on the investments of the rentiers, and caused instead the euthanasia of the savers—or at least the robbing of the savers.

Our recent experience has shown again how borrowers may be made richer by low interest rates, as were speculators, private equity firms, and corporations that levered up with cheap debt. “It is clear that unconventional monetary policies…had a profound impact on inequality,” Chancellor writes, “the greatest beneficiaries from the Fed’s policies [of low interest rates] were the financial elite, who got to enhance their fortunes with cheap leverage at a time when asset values were driven higher by easy money.”

Historically there was a question of whether there should be interest charged at all. “Moneylenders have always received a bad press,” Chancellor reflects, “Over the centuries… the greatest minds have been aligned against them”—Aristotle, for example, thought charging interest was “of all modes of making money…the most unnatural.” The Old Testament restricted charging interest, but as Chancellor points out, the Book of Deuteronomy makes this important distinction: “You shall not lend upon interest to your brother, interest on money, interest on victuals, interest on anything,” but “To a foreigner you may lend upon interest.” This raises the question of who is my brother and who is a foreigner, but does seem to be an early acceptance of international banking. It also makes me think that anyone who has made loans from the Bank of Dad and Mom at the family interest rate of zero, will recognize the intuitive distinction expressed in Deuteronomy.

Needless to say, loans and investments bearing interest prevail around the globe in the tens of trillions of dollars, the moneylenders’ bad press notwithstanding. This is, at the most fundamental level, because interest rates reflect the reality of time, as Chancellor nicely explains. One thousand dollars ten years from now and one thousand dollars today are naturally and inescapably different, and the interest rate is the price of that difference, which gives us a precise measure of how different they are.

A perpetually intriguing part of that price is how interest compounds over long periods of time. “The problem of debt compounding at a geometrical rate has never lost its fascination,” Chancellor observes, and that is certainly true. “A penny put out to 5 percent compound interest at our Savior’s birth,” he quotes an 18th-century philosopher as calculating, “would by this time [in 1773]… have increased to more money than would be contained in 150 millions of globes, each equal to the earth in magnitude, all solid gold.”

The quip that compound interest is “the eighth wonder of the world” is often attributed to Albert Einstein, but Chancellor traces it to a more humble origin: “an advertisement for The Equity Savings and Loan Company published in the Cleveland Plain Dealer” in 1925. “Compound interest… does things to money,” the advertisement continued, “At the Equity it doubles your money every 14 years.” This meant the savings and loan’s deposits were paying 5% interest—the same interest rate used in the preceding 1773-year calculation, but that case represented 123 doublings.

The mirror image of sums remarkably increasing with compound interest is the present value calculation, which reduces the value of future sums by compound interest running backward to the present, a classic tool of finance. Just as we are fascinated, as the Equity Savings and Loan knew, by how much future sums can increase, depending on the interest rate that is compounding, so we are also fascinated by how much today’s market value of future sums can shrink, depending on the interest rate. 

If the interest rate goes from 1% to 4%, about what the yield on the 10-year Treasury note did in 2021-2022, the value of $1,000 ten years from now drops from $905 to $676, or by 25%. You still expect exactly the same $1,000 at exactly the same time, but you find yourself 25% poorer in market value.

Central Bank Distortions

In old British novels, wealth is measured by annual income, as in “He has two thousand pounds a year.” One role of changing interest rates is to make the exact same investment income represent very different amounts of wealth. If interest rates are suppressed by the central banks, it makes you wealthier with the same investment income; if they are pushed up, it makes you poorer. If they change a lot in either direction, the change in wealth is a lot. The math is elementary, but it helps demonstrates why interest rates are, as Chancellor says, the most important price. 

In the 21st century, “The Federal Reserve lowered interest rates to zero and sprayed money around Wall Street.” But if the interest rate is zero, $1,000 ten years in the future is worth the same as $1,000 today, a ridiculous conclusion, and why zero interest rates are only possible in a financial world ruled by central banks.

More egregious yet is the notion of negative interest rates, which were actually experienced on trillions of dollars of debt during the last decade. “The shift to negative interest rates comprised the central bankers’ most audacious move,” Chancellor writes. “What is a negative interest rate but a tax on capital—taxation without representation.” With negative interest rates, $1,000 ten years in the future is worth more than $1,000 today, an absurd conclusion, likewise proof that negative interest rates can only exist under the rule of central banks.

“The setting of interest rates [by central banks] is just one aspect of central planning,” Chancellor observes. In his ideal world, expressed on the book’s last page, “central banks would no longer be able to pursue an active monetary policy,” and “guided by the market’s invisible hand, the rate of interest would find its natural level.” Given all the mistakes central banks have made, with the accompanying distortions, this is an attractive vision, but unlikely, needless to say.

Will The FTX Crash Kill Crypto?

Cited in Forbes:

That includes digital currencies. This the irony which Mises Institute scholar Alex Pollock points out in his new book, Surprised Again!, coauthored with Howard Adler: that crypto’s problems may well speed the digitization of national currencies and increase the power and influence of central banks—the crypto enthusiast’s No. 1 nemesis.

Jan 17 AEI Event: Should the Federal Reserve Raise Its Inflation Rate Target?

Click here to watch live.

Near-zero interest rates prevailed for more than a decade, raising concerns that the Federal Reserve lacked policy tools should stimulus be needed to counteract a recession. While some central banks experimented with negative rates, the Fed adopted quantitative easing (QE) to stimulate the economy without lower rates.

Some economists argue that the Fed should raise its inflation target so that normalized interest rates are high enough to allow interest rate cuts to stimulate the economy without resorting to QE. A recent Wall Street Journal article argues that an optimal inflation target could be as high as 4 percent—or even 6 percent.

Join AEI as a panel of experts discuss arguments for and against changing the Fed’s inflation target.

LIVE Q&A: Submit questions to Beatrice.Lee@aei.org or on Twitter with #AskAEIEcon

Agenda

10:00 a.m.
Introduction:
Paul H. Kupiec, Senior Fellow, AEI

10:15 a.m.
Panel Discussion

Panelists:
Charles Calomiris, Henry Kaufman Professor of Financial Institutions, Columbia Business School
Gerald P. Dwyer, Professor and BB&T Scholar, Clemson University
Thomas Hoenig, Distinguished Senior Fellow, Mercatus Center
Alex J. Pollock, Senior Fellow, Mises Institute

Moderator:
Paul H. Kupiec, Senior Fellow, AEI

11:45 a.m.
Q&A

12:00 p.m.
Adjournment

Click here to watch live.

Among six proposals to regulate cryptocurrency, one is superior

Published in The Hill with Howard B. Adler:

In the wake of billions in losses suffered by investors from the failure of cryptocurrency exchange FTX and other crypto collapses, how to regulate cryptocurrencies is a hot topic the new Congress must address. Competing proposals for it to consider range from banning cryptocurrencies outright, to giving them government backing, to stifling them with regulatory bureaucracy, to letting them fail or succeed entirely on their own. 

Some urge that cryptocurrencies simply be banned. This is the approach taken by China in 2021 when it banned all private cryptocurrency transactions and imposed an official “digital yuan” to monitor its citizens even more. The Chinese approach reflects the belief that currency must be a state monopoly and the official currency must have no private competitors. After FTX, some commentators have asked whether cryptocurrency should be banned in the United States. While banning cryptocurrency may be a characteristic response by an absolutist state like China, we do not believe it is appropriate for the United States. 

A second approach, unsurprisingly advocated by Securities and Exchange Commission Chairman Gary Gensler, is to have the SEC take over cryptocurrency regulation primarily by using its existing powers to regulate securities. Gensler believes that “the vast majority” of crypto tokens are securities already within the SEC’s jurisdiction. Of course, the SEC failed to head off the FTX collapse or any of the other cryptocurrency debacles. A glaring problem with this approach is that it requires the SEC to first assert that a particular form of crypto is a security and then for this issue to be litigated — a slow, expensive and inefficient process. A former SEC chair conceded that Bitcoin, the archetypal and largest cryptocurrency by market cap, is not a security and many cryptocurrencies are structured similarly to Bitcoin. 

The Commodity Futures Trading Commission has proposed that it should be the principal cryptocurrency regulator. This is called for in the Digital Commodities Consumer Protection Act, a bill reportedly pushed by former FTX CEO Sam Bankman-Fried and other members of the cryptocurrency industry. The crypto industry is said to regard the CFTC as a less stringent regulator than the SEC. One proposal is for each cryptocurrency firm to get to choose either the SEC or the CFTC as its regulator.  

From a different perspective, a group of top U.S. financial regulators has put forward a banking-based regulatory approach. This would be applied to stablecoins, a type of cryptocurrency backed by or redeemable at par in dollars (or other government currencies), and intended to maintain a stable value with respect to the dollar. This approach, advanced by the Treasury and the President’s Working Group on Financial Markets, would require that stablecoin issuers be chartered as regulated, FDIC-insured banks. The rationale for this approach is that stablecoin issuers are functionally taking deposits, which is by definition a banking function.  

Regulation as a bank is the most invasive form of financial regulation and imposes very high compliance costs.  For the business models of many cryptocurrency issuers, this may be the functional equivalent of banning cryptocurrency.  (Perhaps this is the outcome actually intended.)  More importantly, the only good thing that can be said about FTX’s and other cryptocurrency failures is that they did not damage the wider financial system or result in taxpayer bailouts.  Requiring cryptocurrency issuers to be FDIC-insured puts them in the federal safety net and puts taxpayers on the hook for future losses.  In our view, creating taxpayer support is going in exactly the wrong direction. 

A fifth approach, in a bill introduced by Sen. Pat Toomey (R-Pa.), would authorize a new type of license from the Office of the Comptroller of the Currency for stablecoin issuers, presumably less onerous than a full banking license and not requiring FDIC insurance. Issuers would be subject to examination and required to disclose their assets and redemption policies. Most importantly, they would be required to provide quarterly “attestations” from a registered public accounting firm. 

As a further step, we believe that disclosure of full, audited financial statements is critical. Right now, most cryptocurrencies are not subject to any kind of accounting disclosure. But no one should ever invest money in an entity that does not provide audited financial statements without recognizing that their funds are at extreme risk. If a federal regulatory system for cryptocurrency is to emerge, financial statement requirements are essential. 

Sixth and finally, it has been proposed that cryptocurrency not be specially regulated at all. Instead, it should be treated like a “minefield,” with appropriate warnings that investors face danger and invest entirely at their own risk. Investors would be able to rely on the protections of general commercial law and existing anti-fraud and criminal laws, but if cryptocurrency ventures crash, they crash, and their debts are reorganized in bankruptcy with losses to the investors and creditors, but not to taxpayers.  

Since cryptocurrency originated as a libertarian revolt against the government monopoly on money, this approach is consistent with its founding ideas. If people want to risk their money, they ought to be allowed to do so. However, they must be able to understand what they are doing. All parties should clearly understand that Big Brother is not protecting them when they hold or speculate in cryptocurrency. 

We believe that this sixth approach is superior in philosophy, but that it needs to be combined with required full, audited financial statements and disclosures about risks and important matters such as assets and redemption policies. Such a combination is the most promising path forward for cryptocurrency regulation. 

Howard B. Adler is an attorney and a former deputy assistant secretary of the Treasury for the Financial Stability Oversight Council. Alex J. Pollock is a senior fellow of the Mises Insitute and former Principal Deputy Director of the Treasury’s Office of Financial Research. They are the coauthors of the newly released book,” Surprised Again! The COVID Crisis and the New Market Bubble.” 

The second housing bubble of the 21st Century ends

Published in the Housing Finance International Journal and re-published in RealClear Markets.

The 21st century, only 23 years old, has already had two giant, international housing bubbles. It makes one doubt that we are getting any smarter with experience.

Among the countries involved in the second bubble, both the U.S. and Canada fully participated in the newest rampant inflation of house prices. Prices this time reached levels far above those of the last boom peak. In the U.S., the S&P/Case-Shiller National House Price Index by mid-2022 had risen to 67% over its 2006 bubble peak (130% over its 2012 trough). In Canada, the Teranet-National Bank House Price Index had soared to 143% over its 2008 peak (168% over its 2009 trough). What the Federal Reserve and the Bank of Canada both wrought with their hyper-low interest rate policies, were house prices which would be unaffordable as soon as mortgage interest rates returned to more normal levels. For a number of years, one could ask: When would that ever happen? Now we know: in 2022.

Now, in late 2022, with mortgage interest rates higher, housing bubbles are deflating, and house prices are dropping on a nationwide basis in both the U.S. and Canada. Here we go again into another house price fizzle following another house price boom.

How is it that we could find ourselves caught up in the problems of another housing bubble so soon? It is only ten years since 2012, the year house prices stopped falling in the U.S., and formed the trough of the painful bust which had followed the preceding bubble of 1999- 2006. Up to the point when house prices started falling across the U.S. last time, expert voices pronounced that U.S. house prices could fall on a regional basis, as they had numerous times, but that it was not possible for house prices to fall on a national basis in an economy so large and diversified. That theory could not have been more mistaken, and national average house prices fell 27%. In 2022, the theory is again being shown to be wrong, but how big the fall will be this time is not known or knowable.

We can take as a key ironic lesson that when large numbers of people believe house prices cannot fall, especially when they are emboldened by central bank behavior, it makes it more probable, and finally makes it certain, that the prices will ultimately fall. When they do, what had been built into everybody’s financial models as “HPA,” or “House Price Appreciation,” becomes instead “HPD”— “House Price Depreciation.” It would be better all along to refer to it as “HPC,” or “House Price Change,” thus reminding ourselves that prices of any asset can go both up and down, perhaps by a lot.

Ten years, it seems, is long enough to dim the memories that prices can move dramatically in both directions, even on a nationwide basis. A bubble market when extended for years makes a great many people happy, since they are making money and seem to be growing richer, and the higher their leverage, the faster they seem to be growing richer. As the great financial observer Walter Bagehot wrote 150 years ago, “the times of too high price” mean “almost everything will be believed for a little while.”

Then the reversal comes and different beliefs come to prevail. In just four months, from June to October 2022, U.S. median house prices dropped a remarkable 8.4%, with prices declining from their peak in all 60 of the largest metropolitan areas in the country. In October, sales of existing houses declined for the ninth month in a row, and were down 28% from a year earlier. Applications for a mortgage to buy a house were down 42% from the year before. Mortgage banks reported they were on average losing money on mortgage originations and many were laying off staff. The share price of 2021’s largest mortgage bank, Rocket Companies, was down 70% from its 2021 high. The CEO of the National Association of Home Builders stated, “We’re heading into a housing recession.”

In Canada, average house prices fell 7.7% from May to October, the largest five-month drop in the history of the Teranet index, which goes back to 1997. In Toronto, the country’s financial capital and a former star of rapid house price inflation, the May to October house price drop was a vertiginous 11.9%. Successive headlines in monthly Teranet-National Bank House Price Index announcements read: “Record price drop in August”; “Another record monthly decline in September”; “Another monthly decline in October.”

In spite of these rapid percentage rates of decline, house prices in both countries are still at very high levels. How much further can they fall from here? For the U.S., the Federal Reserve carefully stated in its latest Financial Stability Report, “With valuations at high levels, house prices could be particularly sensitive to shocks.” Coming to specifics, the AEI Housing Center predicts a 10%-15% nationalaverage fall in house prices during 2023. That would wipe out a lot of housing wealth that the bubble made people think they had, a reduction of perhaps $4 or $5 trillion of perceived wealth on top of the $3 trillion lost so far this year. It would put many houses bought near the top of the market, especially under government low- down payment programs, into no or negative owner’s equity.

For Canada, the Wall Street Journal suggested that its housing market is “particularly sensitive to monetary tightening,” and reported that Oxford Analytics “estimates that home prices in Canada could fall 30%.”

Recall that a price has no substantive reality: it is an intersection of human expectations, actions, hopes and fears. I like to ask audiences, “How much can the price of an asset change?” My proposed answer: “More than you think.”

Of course, nobody, including the Federal Reserve and the Bank of Canada, knows just where house prices will go, but we can all guess. Noted economist Gary Shilling wrote in November, “Price declines are just starting,” and “recent weakness probably has far to go.” This seems to me likely.

In any case, the second great housing bubble of this still young century is over and a new phase has begun.

Letter: The Fed’s accounting ploy has echoes of S&L crisis

Published in the Financial Times:

Your article “Central banks: Rising losses risk bailouts and political pressure” (Report, December 12) points out that central banks, having bought a lot of low-yielding bonds together, are now losing a lot of money together. Do these losses matter? You quote a Danske Bank strategist saying “central banks do not aim to make profits” — a comment offered as a rationalisation. But this is contradicted by the fact that central banks are all structured precisely to make money by seigniorage from their currency monopolies. As for the Federal Reserve, whose losses are rapidly mounting, its so-called “deferred asset” accounting is not a solution, but simply a phoney accounting used to keep the losses from reducing the Fed’s publicly reported net worth, or rendering it negative. This is the same accounting ploy used by insolvent savings and loans in the 1980s during the collapse of their industry. This has some poetic justice since the Fed, with its $2.7tn of fixed rate mortgage assets, has inside it the financial equivalent of the largest savings and loan in the world by far. Alex J Pollock Lake Forest, IL, US

Profligacy in Lockstep

Published in Law & Liberty and re-published in RealClear Markets with Paul Kupiec:

The Swiss National Bank’s (SNB) financial statements for the nine months ending September 30, 2022, show a bottom-line loss of US$150 billion.* A number to get your attention!

Under the strong financial discipline of its charter act, the SNB must mark its investments to market, and reflect any market value loss or profit in its income statement and capital account. From having capital of $221 billion at the end of 2021, the SNB’s capital has been reduced by 73% to $59 billion on September 30 due to falling market prices. Still, the SNB has a capital ratio—a bank’s equity to its total assets—over 6%.

In contrast, the Federal Reserve’s reported capital ratio, which does not reflect the Fed’s massive mark-to-market losses, is 0.5%. The Federal Reserve Bank of New York, by far the largest of the Federal Reserve Banks, has a reported capital ratio of 0.3%—again not counting its market value losses. “It helps the credibility of the central bank to be well capitalized,” said the Vice Chairman of the SNB in October 2022. Presumably, the Fed does not agree.

With Swiss candor, the Chairman of the SNB observed, also in October 2022, that many central banks “brought down longer-term interest rates by buying government and corporate bonds. This increased central banks’ balance sheets and the risks they bear.” (italics added) They certainly did run up their risk, all together, and now the big risks they assumed are turning into losses all around the central bank club.

The Reserve Bank of Australia announced in September that losses on its investments caused its capital to drop to a negative $8 billion on June 30. Its Deputy Governor admitted that “If any commercial entity had negative equity… [it] would not be a going concern,” but maintained, “there are no going concern issues with a central bank in a country like Australia.” Nonetheless, it’s pretty embarrassing to have lost more than all of your capital.

The Bank of England joined “the club of major central banks showing negative net worth” if its investments are marked-to-market, Grant’s Interest Rate Observer reported. Thus far, the Bank has lost $230 billion on its bond investments, 33 times the Bank’s capital of $7 billion as of February 2022, its fiscal year-end. Fortunately for the Bank, it has an indemnity from His Majesty’s Treasury—that is, the taxpayers—to cover the losses. “I am happy to reaffirm…that any future losses incurred by the Asset Purchase Fund will be met in full by the Government,” wrote a Chancellor of the Exchequer. In July 2022 the Financial Times summed it up: “With an indemnity provided by HM Treasury the Bank of England need not fret.” But should the taxpayers who bear the loss fret?

The Bank of Canada carries most of its investments at market value, and its financial statements reflect market value losses of $26 billion as of November 2022. These mark-to-market losses would render the bank’s capital negative were it not for a formal indemnity agreement it has with the Government of Canada. The Canadian government has contractually agreed to make up any realized losses on the Bank’s bond purchase programs. That’s a good thing for the Canadian central bank, since its capital ratio is only 0.1%.

While the Bank of Canada’s financial statements do show that its investment losses put the taxpayers at risk, you have to read the financial statement footnotes carefully to understand what the accounting means. The Bank carries an asset called “Derivatives: Indemnity agreements with the Government of Canada.” This asset is the amount that the government is on the hook for—in other words, it equals $26 billion in mark-to-market losses. Since the Bank’s total reported capital is only about $0.5 billion, the real capital of the Bank is its claim on Canadian taxpayers to reimburse its losses.

Now having created the same risks together, the world’s central banks are suffering big losses together.

The European Central Bank (ECB) has assets of over $9 trillion and a capital ratio of 1.3%. How do its mark-to-market losses compare to its $119 billion in capital? It’s hard to tell, but a German banking colleague wrote us, “ECB is not really transparent, [but] you can guess… Expect price losses in its portfolio of about $800 billion.” If his informed guess is accurate, the ECB has negative capital of about $680 billion on a mark-to-market basis. As our colleague also pointed out, many of the ECB’s investments are low-quality sovereign bonds. It will be interesting indeed to see how these ECB problems play out.

In September, the Governor of the Dutch central bank, De Nederlandsche Bank (DNB), formally wrote to the Ministry of Finance to discuss the Bank’s looming losses, and how “a situation may arise in which the DNB is faced with negative capital.” This is without considering the mark-to-market of its bond portfolio, because the DNB uses accounting conventions, like the Federal Reserve, that do not recognize mark-to-market losses on its QE investments.

“In an extreme case,” the letter continued, “a capital contribution from the shareholder may be necessary.” The sole shareholder is the Dutch government, so once again the cost would be transferred to the taxpayers.

In this unattractive situation the DNB has plenty of company: “All central banks implementing purchase programs, both in the euro area and beyond, are facing these negative consequences,” the Governor observed, adding that these included the Federal Reserve, the Swedish Riksbank, and the Bank of England.

Then, in an October television interview, the Governor brought up the old-fashioned idea of gold. The DNB’s negative capital problem could be ameliorated or avoided he said, by counting as capital the large unrealized profit on its gold. The Bank does mark its 19.7 million ounces of gold to market but keeps the appreciation in a separate $33 billion accounting “reserve,” which is not included in its capital account.

Although it is against the current rules of the Euro system, it would make perfect sense to include the market value of the gold when calculating the DNB’s capital, as the Swiss National Bank does. (This idea would not help the Federal Reserve, because it owns no gold.) It is no small irony that, to bolster their capital, modern fiat currency central banks would consider turning to the value of the “barbarous relic” of gold, against which their own currencies have over time so greatly depreciated.

Coming to the world’s leading central bank, the mark-to-market loss on the Federal Reserve’s investments, as we have previously written, is huge—estimated at a remarkable $1.3 trillion loss as of October 2022. This is 30 times the Fed’s total capital of $42 billion. More immediately pressing, the Fed is now running operating losses that it does recognize in its profit and loss statement of $1 billion or more a week, or annualized losses of $50 to $60 billion. Not counting the mark-to-market losses on its investments, the Fed’s operating losses at this rate will exceed its capital in less than a year.

Complicating the problem, the shares of the Federal Reserve Banks are owned not by the government, but by Fed member commercial banks. Under the Federal Reserve Act, the Fed’s shareholders are required to be assessed for a portion of any losses, but the Fed has thus far seemed to ignore the law and is sharing its operating losses with the taxpayers instead.

“Major central banks tend to move together,” as economist Gary Shilling pointed out recently. We believe this is because the major central banks are a coordinating elite club. They do not and cannot know the financial and economic future, and they must act based on highly unreliable forecasts. They face, and know they face, deep and fundamental uncertainty. Under these circumstances, intellectual and behavioral herding is natural and to be expected. Now having created the same risks together, they are suffering big losses together. In many cases, the accumulating losses will exceed central bank capital and be borne by the taxpayers.

*All currencies have been translated to US dollars at mid-November exchange rates.

Dec. 7: AEI: Surprised Again!―The COVID Crisis and the New Market Bubble

Hosted by the American Enterprise Institute. Also video on C-SPAN here.

Alex Pollock and Howard Adler were senior US Treasury officials during the financial markets’ bust-to-boom cycle of the COVID-19 crisis. Their new book, Surprised Again!—The COVID Crisis and the New Market Bubble (Paul Dry Books, 2022), analyzes how the government’s crisis response affected the US financial system. Their clear exposition of the financial stability risks lurking in the Federal Reserve, housing, pension funds, municipal finance, student loans, and cryptocurrencies may surprise many readers with the extent of the financial system problems hiding in plain sight.

Join AEI as Christopher DeMuth and Paul Kupiec engage Mr. Pollock and Mr. Adler in a discussion of the many important issues the authors raise in Surprised Again!

LIVE Q&A: Submit questions to Beatrice.Lee@aei.org or on Twitter with #AskAEIEcon.

Agenda

5:00 p.m.
Introduction:
Paul H. Kupiec, Senior Fellow, AEI

5:10 p.m.
Book Preview:
Alex J. Pollock, Senior Fellow, Mises Institute
Howard B. Adler, Former Deputy Assistant Secretary of the Treasury, Financial Stability Oversight Council

5:35 p.m.
Discussion:
Christopher DeMuth, Distinguished Fellow, Hudson Institute
Paul H. Kupiec, Senior Fellow, AEI

6:00 p.m.
Q&A

7:00 p.m.
Adjournment

Dec. 15: Johns Hopkins: "Surprised Again!" Book Conversation with Howard Adler & Alex Pollock

Hosted by Johns Hopkins University:

Sponsored by Alumni in Government, Education, Law & Policy, Alumni in Real Estate, Administration & Finance, Alumni in Arts, Media, Athletics and Entertainment and the Office of Alumni Relations Lifelong Learning

Are you interested in finance or even the economy? Join former Treasury officials, Howard Adler and Alex J. Pollock as they present their book "Surprised Again!:The COVID Crisis and the New Market Bubble". Howard and Alex will present Chapter 6, “Cryptocurrencies: An Assault on central Banks or Their New Triumph?”  and Chapter 12, “Central Banking to the Max” and discuss the impact of the COVID pandemic and the economic bubbles in the economy.  Dive in for the opportunities to ask questions and get answers! 

Learn more and purchase this well reviewed book here at https://www.pauldrybooks.com/products/surprised-again-the-covid-crisis-and-the-new-market-bubble and also available through most book sellers including Amazon, Barnes & Noble, Target, Walmart, etc.

Surprised Again! Book Overview

About every ten years, we are surprised by a financial crisis. In 2020, we were Surprised Again! by the financial panic of the spring triggered by the Covid-19 pandemic. Not one of the 30 official systemic risk studies developed in 2019 had even hinted at this financial crisis as a possibility, or at the frightening economic contraction which resulted from the political responses to control the virus. In response came the unprecedented government fiscal and monetary expansions and bailouts. Later 2020 brought a second big surprise: the appearance of an amazing boom in asset prices, including stocks, houses, and cryptocurrencies.

Alex Pollock and Howard Adler lived through this historic instability while serving as senior officials of the U.S. Department of the Treasury. Their book lays out the many elements of the panic and its aftermath, from the massive elastic currency operations which rode to the rescue by financing the bust with unprecedented government debt, to the consequent asset price boom, which included a renewed bubble in house prices financed by government guarantees. It considers key leveraged sectors such as commercial real estate, student loans, pension funds, banks, and the government itself. It reflects on how to understand these events both in retrospect and prospect.

Surprised Again! The COVID Crisis and the New Market Bubble

Published in Library Journal:

by Alex J. Pollock & Howard B. Adler

Paul Dry. Nov. 2022. 222p. ISBN 9781589881655. pap. $21.95. ECONOMICS

COPY ISBN

As former senior officials of the U.S. Department of Treasury under the Trump administration, Pollock (Finance and Philosophy: Why We’re Always Surprised) and Adler are qualified to synthesize complex financial behaviors into digestible chapters; the graphs they include are excellent. This book analyzes prime money market funds, cryptocurrencies, mortgages, municipal debt, pension debt, and student loans, in regard to their pre and current pandemic behavior. Each chapter serves as a primer and an update of each category. The authors argue that all finance is political finance, and they believe that predicting financial market behavior is ineffective, since many times those forecasts are wrong or surprising. Salient points are emphasized with a “Dear Reader” salutation that is both annoying and effective, as the examples in those paragraphs are essential for understanding. The chapters on prime market funds and cryptocurrencies are especially enlightening due to their exploration of regulations, both real and theoretical, that influence their behavior. Although the book is designed to be read in sequence, readers looking to delve into these topics beyond daily media coverage will be able to start at the chapter they’re most interested in.

VERDICT A helpful and insightful analysis of current economics.

Reviewed by Tina Panik , Nov 01, 2022

William Isaac Announcements: October 28, 2022

October 28, 2022

My good friend, Alex Pollock and his colleague, Paul Kupiec, co-authored an article on the Federal Reserve, which was just published by The Hill. The legislation creating the Consumer Financial Protection Bureau required the CFPB to be headed by a single individual instead of a bipartisan board governing most independent agencies such as the FDIC, the SEC, the FTC. Moreover, the CFPB receives its funding from the Federal Reserve Board instead of being funded by Congress. A Federal Court recently ruled – I believe correctly – that these governance arrangements are unconstitutional. Alex and Paul address these issues and go on to note that the Federal Reserve is hardly in position to fund the CFPB. I highly recommend this article to you.

• The Fed is in the red: Should it still pay CFPB’s bills? By Alex J. Pollock and Paul Kupiec published by The Hill on October 26, 2022

The article can be found at williamisaac.com. Be safe and be well.