How Can It Be That a ‘Thief in the Night’ Is Loosed by the Federal Reserve Under the Nose of a Passive Congress?

And what would it mean if Congress were active in the decisions?

Published in The New York Sun and also the Federalist Society.

The Federal Reserve is a problem for the constitutional order of our republic. How can it be that the central bank considers itself able to unilaterally impose permanent inflation on the country, without legislative debate or approval?

The shifting theories believed by central banks are among the most important of macro-economic factors. The chairman of the Federal Reserve Board between 1951 and 1970, William McChesney Martin, characterized inflation as “a thief in the night.” 

In remarkable contrast, the Fed under Ben Bernanke, chairman between 2006 and 2014, explicitly committed itself and the country to inflation forever at the rate of 2 percent a year, thus assuming that constant inflation should not only be taken for granted, but pursued. 

If the purchasing power of the currency continuously depreciates at the rate of two percent per year, as the Fed now promises, in the course of a single lifetime, average prices would quintuple. At three percent, as is sometimes suggested, prices in a lifetime would multiply by ten times. At four percent, they would multiply by 23 times.

Is this the kind of money the American people want? I don’t think so. Congress did acquiesce in the 1970s to the executive move to fiat money, untied to gold, as previously required by the Bretton Woods agreement, and later removed legislative ties of the dollar to gold. 

That’s the kind of money wanted by those who long to expand government power and finance it by an unlegislated inflation tax. The Congress didn’t, though, call for, enact, or approve a policy of pursuing inflation per se.  It wrote into the Federal Reserve Reform Act of 1977 a requirement that a principal goal of the Fed is “stable prices.”

The nature of money and the stability of its value is an essential political and social question. William Jennings Bryan famously proclaimed, “You shall not crucify mankind upon a cross of gold.” On the other hand, we may proclaim, “You shall not drown mankind in a flood of paper money.” Who gets to choose between inflationist money and sound money?

Not the Fed by itself. Coining money, and regulating the value thereof,  are questions profoundly requiring the Congress. They are specifically enumerated in the Constitution as among the powers granted, in Article One, Section Eight, to Congress.

The press is full of references to “the Fed’s” two percent inflation target. But if there is to be such a target, it should be “the country’s” target, not “the Fed’s” target. The Fed’s proposal to constantly depreciate the people’s money should have been presented to the elected representatives of the people for approval or rejection. It wasn’t.

How in the world did the Fed imagine that it had the authority all on its own to commit the nation to perpetual inflation and depreciation of the currency at some rate of its own choosing? The only explanation I can think of is pure arrogance. 

Being the most powerful financial institution in the world and the purveyor of the dominant fiat currency might lead the Fed to an excessively high opinion of its own authority. At the same time, the Fed has crucial and dangerous inherent weaknesses.

It has demonstrated beyond question its inability to predict the financial and economic future. It can inflate disastrous asset price bubbles as well as consumer prices. It is unable to know what the results of its own actions will be.

This inability is notably shown by its own financial performance: a net loss of $111 billion since September 2022, as reported on October 19, tens of billions in net losses still to come, and a mark to market loss on its investments of more than $1 trillion.

Congress should, first and foremost, amend the Federal Reserve Act to make it clear that setting any “inflation target” requires review and approval by Congress, as a public choice between kinds of money. And make it clear that the Fed lacks  unilateral power to decide the nature of the money the Congress provides.

Congress should also cancel the two percent inflation target announced by the Fed, until the Congress has approved such an action or provided some other guidance — say, “stable prices” — a goal that is already stated in the Federal Reserve Act, but is being evaded.

Stable prices imply a long-run average inflation rate of approximately zero — in other words, a goal of sound money. All in all, we need to control the powerful and dangerous Federal Reserve by using the checks and balances of our constitutional republic.

Letter: Fed rates slogan should read: ‘Normal for longer’

Published in the Financial Times.

From Alex J Pollock, Senior Fellow, Mises Institute, Lake Forest, IL,

With your page one headline “Fed’s ‘higher for longer’ interest rate message weighs on stocks and bonds” (Report, September 28), the Financial Times joins the chorus of commentators singing a similar tune.

But interest rates are not particularly high — they are normal, historically speaking.

For example, in the half-century from 1960 to 2010, before a decade of suppression of interest rates to abnormal lows by the Federal Reserve and other central banks, the 10-year US Treasury note yielded more than 4 per cent, for 90 per cent of the time.

Interest rates only seem high because we got used to the abnormal lows.

So the right slogan now is not “higher for longer,” but “normal for longer”.

The Federal Reserve loses billions on mortgages

Published in Housing Finance International.

Can house prices achieve a soft landing?

The largest holder by far of residential mortgages in the United States, a country often supposed to favor private markets, is none other than the central bank, the Federal Reserve. The Fed owns the remarkable sum of $2.5 trillion (that’s “trillion” with a T) in mortgage-backed securities (MBS).[1] That is more than one-quarter of the entire federal agency residential MBS market, the dominant U.S. source of housing finance. The Fed has mainly invested this enormous amount in the typical American 30-year fixed rate, freely prepayable, mortgage, an instrument of notorious interest rate risk. This risk infamously sank the savings and loan industry in the 1980s, and in 2023 was a principal factor in sinking Silicon Valley Bank, the second largest bank failure in U.S. history at the time of its collapse.

In this Fed MBS investment program, the entire risk of the mortgage is absorbed by the government: the credit risk of the Fed’s MBS investments is taken by other government organizations (Fannie Mae, Freddie Mac, Ginnie Mae), but the Fed itself bears 100% of the interest rate risk. How has the Fed managed this risk as interest rates have dramatically risen since 2022? Not well.

Faced with the runaway inflation of 2021- 22, the Fed pushed short-term interest rates rapidly up from close to zero to 5 ½% after it belatedly stopped buying MBS. Interest rates on 30-year mortgage loans have more than doubled from less than 3% to more than 7%. The resulting mark-to market on the Fed’s MBS portfolio is a loss of $394 billion as of June 2023, or more than 9 times the Fed’s total capital of $42 billion. Striking numbers![2]

The Fed’s huge purchases of mortgage securities began as an emergency, “temporary” action in the crisis of 2008, accelerated again in the Covid financial crisis of 2020, and lasted longer than needed—until March 2022. These central bank purchases drove the interest rates on 30-year fixed rate mortgage loans down to under 3% in late 2020 and 2021-- as low as 2.7% in late 2020—not much return for a 30-year risk! —and the yields on MBS can run 1% or so lower than the mortgage loan rates. The Fed bought a lot of MBS at the bottom in MBS yields—that is, it bought a lot at the market top in MBS prices which its own buying created.

In a leveraged balance sheet like the Fed’s, mark to market losses move into operating results through negative interest spreads. The Fed now has a $2.5 trillion MBS portfolio yielding a little over 2%, which to finance, it pays its depositors and repurchase agreement lenders over 5%. So this massive investment is now running at an interest rate spread of about negative 3%.

One hardly needs to say that lending at 2% and borrowing at 5% is a losing proposition. The $2.5 trillion MBS investment at a negative 3% spread is costing the Fed (and the Treasury and the taxpayers) about $75 billion a year. When added together with the rest of the Fed’s operations, principally the profits from issuing currency and losses from investing in long-term Treasury securities, the Fed accumulated from September 2022 through the end of August 2023 net losses of the notable sum of $95 billion.[3]

The losses will clearly continue for the rest of 2023, by which time the Fed will have lost on operations about three times its capital, and on into the future if interest rates stay at their current historically normal levels. Since the Fed’s profits mostly go to the Treasury, its losses mean that the U.S. Treasury and the taxpayers also lose. The many banks which also bought MBS and hold fixed-rate mortgage loans acquired at 3%, also have very large mark-to-market losses and negative spreads on them. These banks, like the failed Silicon Valley Bank, could correctly claim that they were only doing the same thing the Federal Reserve was.

From the point of view of mortgage borrowers, those who borrowed at 3% or less for 30 years obviously got a great and very attractive deal. A current borrower at 7.2% has to pay 2.5 times as much in monthly interest to buy the same house at the same price as a lucky 2.7% borrower did. On a house in the median price range costing $400,000, that is $1,500 more a month. Naturally, this much more expensive mortgage financing puts a downward pressure on house prices, but it also gives former borrowers a strong motivation to stay in their current houses and keep them off the market, in order to preserve the large financial advantage of the great 30-year mortgage rate the Fed created.

The astronomical house price increases of the second great American house price bubble of the 21st century are over. National average house prices, according to the S&P CoreLogic Case-Shiller Index, fell 1.2% yearover-year in June 2023. Over the same period, U.S. consumer price inflation was 3%, so in inflation-adjusted (real) terms, house prices fell 4.2%. That is a far cry from the bubble’s annualized increases in nominal terms which reached 18% and more in 2021 and early 2022. However, U.S. house prices have not fallen as much as many, including me, expected.

Serious reductions in house prices have indeed occurred in overpriced cities in the U.S. West. These year-over-year decreases reported by Case-Shiller as of June 2023 include the following. In real terms, the drops are in double digits.

House Price Changes Year-Over-Year June 2023

| Nominal | Real

San Francisco | -9.7% | -12.7%

Seattle | -8.8% | -11.8%

Las Vegas | -8.2% | -11.2%

Phoenix | -7.5% | -10.5%

These drops are, however, from very high peaks, and prices in these areas remain historically high.

The two metropolitan areas with the largest price increases in the June Case-Shiller report are the Midwestern cities of Chicago, at +4.2%, and Cleveland, at +4.1%, being in real terms, 1.2% and 1.1%, respectively, which are similar to the long-term growth rate in real house prices.

The AEI Housing Center finds that in July 2023, national average house prices increased year-over year by 3.5%, or by +0.3% real, after falling year-over-year in real terms for eight months in a row. Can falling real prices becoming more or less flat make for a “soft landing” of U.S. average house prices? Maybe--considering that 7% is in a historically normal range of mortgage interest rates. It only seems so high to us because of the previous suppression of mortgage rates to abnormally low levels by the Fed.

Still, many observers wonder why U.S. house prices have not fallen more, given the large reduction in buying power for most people from the sharply increased cost of mortgage loans.

Two measures which have dropped like a rock are the volume of home sales and of mortgage originations. Sales of existing houses were down 40% in July 2023 compared to the pre-pandemic July 2019[4] . The volume of interest rate commitments for new mortgage loans is down about 30%- 40% from 2019, and the volume of mortgage refinancings (“refis” in U.S. parlance) simply to lower the interest rate, is correspondingly down 95%.[5] The mortgage banking and brokerage businesses are experiencing heavy stress and their own painful recession with the disappearance of business volumes. Their total staffs have been cut by 43,000 employees or about 11% over the last year.[6]

How can house prices stay high while sales volume shrivels?

One factor is that while sales of existing houses are way down, so is the inventory of houses being put up for sale. The July 2023 inventory of houses for sale was down 36% from July 2019, which helps support house prices.[7]

A popular and plausible theory is that this low inventory at least in part reflects the desire of the lucky mortgage borrowers at 3% or less to hang on to their great mortgages by simply staying in their current houses. As a typical article explains, “Borrowing costs have not had the expected effect of cooling house prices [because] most US homeowners…have in effect been trapped in their properties by [the] low rates.” So the Fed’s manipulation of mortgage interest rates to exceptionally low levels created an unexpected factor to later restrict the supply of houses for sale and help hold house prices up. In addition, when working from home, the borrowers don’t have to change houses to change jobs, which supports the ability to hang on to the old mortgage.

These factors help slow prepayments of 30-year mortgage loans, extend the duration of the Fed’s MBS portfolio, and increase the Fed’s mark-to-market and operating losses.

It doesn’t help right now, but as a long-term strategy the Federal Reserve needs to return the amount of MBS in its balance sheet to what it always was from its founding in 1913 to 2008--namely zero.

_________

1 Federal Reserve H.4.1 Release, August 31, 2023, Section 5.

2 Federal Reserve Banks Combined Quarterly Financial Report, June 30, 2023.

3 Federal Reserve H.4.1 Release, August 31, 2023, Section 6.

4 AEI Housing Center, Home Price Appreciation Index report, July 2023.

5 AEI Housing Center, Housing Market Indicators report, August 1, 2023.

6 “Nonbank mortgage jobs undergo a seasonal dip,” National Mortgage News, September 1, 2023.

7 AEI Housing Center, Home Price Appreciation Index report, July 2023.

8 “Investors keep close eye on US mortgage rates,” Financial Times, September 3, 2023.

Why the Fed’s Unprecedented Losses Matter

Published in The Wall Street Journal.

The Federal Reserve’s risky policy has backfired.

Mr. Furman excuses the Fed’s unprecedented losses, which have surpassed $100 billion on their way to $200 billion or more, suggesting taxpayers shouldn’t care. To the contrary, taxpayers should care that the Fed will spend, without authorization, $200 billion or more that will be added to their future taxes.

These Fed losses are the result of a radical and exceptionally risky Fed choice to build a balance sheet resembling a giant 1980s savings and loan. In the process, it stoked bubbles in bonds, stocks, houses and cryptocurrencies, in addition to inducing enormous interest-rate risk in the banking system. Those risks have now come home to roost.

Mr. Furman argues that the Fed’s negative capital position doesn’t matter. If so, why cook the books to avoid reporting it? The Fed books its cash losses as a “deferred asset” so that it can obscure its true negative capital position. The Fed changed its own previous accounting rules precisely so it could do so. We know what would happen if Citibank tried that.

Who authorized the Fed to take an enormous interest-rate bet, risking taxpayer money? Nobody but the Fed itself. Does “independence” give the Fed the right to spend hundreds of billions of taxpayer dollars without congressional approval? That question needs to be debated.

Alex J. Pollock and Paul H. Kupiec

Mises Institute and AEI

Lake Forest, Ill., and Washington

The Fed’s losses have passed $100 Billion: What’s next?

Published in The Hill and RealClear Markets.

There has just been a landmark event at the Federal Reserve: Its accumulated operating losses have passed $100 billion. This startling number, which would previously been thought impossible, was reported on Sept. 14, 2023, in the Fed’s H.4.1 Release.

It is essential to understand that these are not mark-to-market paper losses; they are real cash losses resulting from the Fed’s expenses being to this remarkable extent greater than all its revenue. These are equally losses to the U.S. Treasury and thus costs to the taxpayers; nonetheless the Fed keeps officially insisting that its losses don’t matter. (Meanwhile the Fed’s mark-to-market losses are more than $ 1 trillion in the most recent public report.)

The Fed started posting operating losses in September 2022, so it has taken only 12 months to produce this ocean of red ink. Looking forward, annualizing the year-to-date results suggests the Fed’s net loss for calendar year 2023 will be about $117 billion. 

We must add the $17 billion it lost in the last four months of 2022, so at the end of 2023, the accumulated losses of the Fed may be about $134 billion. That means the losses will have run through the Fed’s entire capital of $43 billion, plus another $91 billion, for losses of more than three times its capital. What comes next?

The losses will continue into 2024. As long as short-term interest rates stay at their current historically normal levels of around 5 percent (that is, if we have “normal for longer”), what the Fed has to pay on its deposits and borrowings will create a punishing negative spread against the Fed’s trillions of very long-term, low yielding investments. 

Since the Fed bought heavily at the top of the market and the bottom in yields, these investments yield on average only about 2 percent. It doesn’t take a Ph.D. in finance to see that lending at 2 percent while borrowing at 5 percent will not be a winner.

The Fed owns $5 trillion of Treasury securities, of which $4 trillion have more than one year left to run, $2.3 trillion more than five years and $1.5 trillion more than 10 years.  (One of its investments is in the Treasury 1.25 percent of 2050, for example.)  

The average yield on these Treasury securities is 1.96 percent, according to the most recent Fed Quarterly Financial Report. The Fed also owns $2.5 trillion of 30-year mortgage-backed securities (MBS), of which $2.4 trillion have remaining maturities of more than 10 years. 

The MBS have an average yield of 2.20 percent. Combined, that suggests an overall yield of 2.04 percent, which compares to a current funding cost of deposits and repurchase agreements of about 5.37 percent. Voila the Fed’s problem: A negative spread of more than 3 percent on investments with very low yields locked in for years to come. In short, the Fed made itself into a gigantic version of a 1980s savings & loan.

An estimate of the Fed’s running rate of losses in very rounded numbers is as follows.  It has $7.5 trillion of investments yielding 2 percent. Of this, $2.3 trillion are financed at zero interest cost by circulating dollar bills, so the Fed is making about $46 billion a year from its government-granted monopoly of currency issuance. There are about $5.2 trillion of remaining investments financed at a -3 percent spread for an annual loss of $156 billion. There are $9 billion in overhead expenses. The approximate annualized running rate is thus:

                           Profit from currency monopoly                        $46 billion

                           Loss on leveraged investments                        ($156 billion)

                           Operating expenses                                           (9 billion)

                           Net (Loss)                                                            ($119 billion)

By mid-2022, the Fed knew it had serious operating losses looming and published a projection of them. Its base case projection was for a peak cumulative loss of $60 billion — the reported $100 billion loss is already a lot more than that, let alone the $134 billion loss likely by the end of 2023. And the ultimate peak losses will be far greater still — if 2024 is anywhere near as bad as 2023, that alone takes it far over $200 billion. (The Fed also considered a remote, “tail risk event” of its mark to market losses reaching $1.1 trillion. With its current mark to market loss, the “tail risk event” has already happened.)

The Fed should regularly provide Congress updated calculations of the possible path of its future losses. From what has been reported so far, we know that to struggle back to break even, the Fed will have to wait what looks like years for its underwater investments to roll off, or short-term rates would have to fall a lot, or some combination of these. 

We might guess that, for example, it will take a runoff of $3 trillion of its long-term investments with a drop in short-term interest rates to 4 percent to get close to break even.

Failing that, and in the meantime, the Fed itself, the Treasury and the taxpayers will be suffering continuing huge losses. We will simultaneously be running an interesting test of the Fed’s claim that these losses don’t matter.

Reforming the Federal Reserve

Published in Law & Liberty.

The Federal Reserve creates and manipulates the dominant fiat currency of the world. It produces the inflation of its supply and the continuous depreciation of its purchasing power. It manipulates dollar interest rates and the cost of debt, makes elastic the availability of credit (especially during financial crises), finances the government, and monetizes federal deficits in amounts limited only by the statutory debt ceiling. It is often imagined to be “managing the economy,” although, in fact, no one can successfully do that. It is a central bank not only to the United States, but to the entire dollar-using world. In short, the Fed is the most powerful financial institution there is or ever has been. That such a power is concentrated in a single, unelected institution is a problem for the constitutional order of the American republic.

Equally fundamental is that the Fed is always subject to deep uncertainty. It has clearly demonstrated its inability (like everyone else’s) to predict the economic or financial future, and it is inherently unable to know what the results of its own actions will be. Its remarkable power combined with its inescapable lack of knowledge of the future makes it the most dangerous financial institution in the world. This is true no matter how intelligent or brilliant its officers may be, however good their intentions, however many hundreds of economists they hire, or however complex the computer models they build. 

At the famous Jackson Hole central banking conference in August 2023, Fed Chairman Jay Powell, with admirable candor, pointed out some essential uncertainties in the current Federal Reserve debates. “We cannot identify with certainty the neutral rate of interest, and thus there is always uncertainty” about monetary policy, which is “further complicated by uncertainty about the duration of the lags” with which the policy operates and the “changing dynamics [that] may or may not persist.” He continued, “These uncertainties, both old and new, complicate our task.” They certainly do, and this is true of the Fed’s monetary issues at all times.

Powell used an apt metaphor in this respect: “We are navigating by the stars under cloudy skies.” The President of the European Central Bank, Christine Lagarde, used a different metaphor: “There is no pre-existing playbook for the situation we are facing.” But the former Governor of the Bank of England, Mervyn King, in his book, The End of Alchemy, drew a blunter conclusion from it all: “If the future is unknowable, then we simply do not know and it is pointless to pretend otherwise.”

All this should increase our skepticism about how much independent power central banks should have, and whether there is a meaningful path for reform.

Uncertainty and Big Losses 

A good example of the results of uncertainty is the Fed’s own dismal financial performance and growing technical insolvency. The Federal Reserve made net losses of $105 billion as of September 27, 2023 since September 2022. That shocking number is getting rapidly bigger. The Fed continues to lose money at the rate of about $9.5 billion a month or $114 billion a year and the losses may continue for a long time. The accumulated losses are already more than double the Fed’s total capital of $43 billion—indeed, the losses had shriveled its capital, when properly measured under Generally Accepted Accounting Principles (GAAP), to negative $50 billion when Chairman Powell was speaking at Jackson Hole. The Fed’s properly measured capital is likely headed for a negative $100 billion or worse by early 2024. The Fed finances this negative capital by borrowing, which increases the consolidated government debt and is a cost to taxpayers. 

The scale of the losses it is suffering doubtless came as a surprise to the Fed. This is apparent from the woefully inaccurate forecasts of continued “lower for longer” interest rates which it made while amassing trillions of investments in long term, fixed-rate Treasury and mortgage securities with very low yields—including, for example, the 1.25% Treasury bond not maturing until 2050—and funding them with floating rate liabilities. In doing so, the Fed created for its own balance sheet a $5 trillion interest rate risk position similar to that of a giant savings and loan. Such a position would inevitably produce huge losses if interest rates rose to anything like historically normal levels of 4% or 5%. They did, and the losses have followed.

It is impossible to believe that the leadership of the Federal Reserve planned and consciously intended to lose over $100 billion. (As you read this, ask yourself if you believe it.) Fed officials knew they had created a very large interest rate risk position, but as an old boss told me long ago, “Risk is the price you never thought you would have to pay.” The combination of the unknowable future with great financial power joined forces to put this massive cost on the taxpayers without a vote of the Congress.

An Independent Power?

Should the Fed have been able unilaterally to commit the country to perpetual inflation and perpetual depreciation of the dollar’s purchasing power at the rate of 2% per year? The correct answer is “no.”

The media is full of references to “the Fed’s” 2% inflation target—but it should be “the country’s” target. The Fed’s proposal about the nature of the people’s money should have been presented to the elected representatives of the people for approval. The U.S. Constitution provides among the powers of the Congress: “To coin Money [and] regulate the Value thereof.” Regulating the value of the national money and deciding whether it should be stable, or perpetually depreciating, and if so, at what rate, involve inherently political questions. 

Let us review the always-striking math of compound growth rates and apply it to inflation. Stable prices imply a long-run average inflation of approximately zero. At 1% inflation, average prices will more than double in a lifetime of 80 years. At 2% inflation, prices will quintuple. At 3%, they will go up by 10 times. At 4% inflation, prices in a lifetime will go up by 23 times. Which would the sovereign people through their representatives choose? William Jennings Bryan famously proclaimed, “You shall not crucify mankind upon a cross of gold.” How about “You shall not drown mankind in a flood of fiat money”? This is not up to the Federal Reserve to decide on its own.

The Federal Reserve Act specifies “stable prices” as an institutional Fed goal. The concept of “stable prices” is not the same as “a stable rate of inflation,” which the Fed now calls “price stability,” a misleading rhetorical shift.

It is often claimed, especially by the Fed itself, that the Federal Reserve is, or at least ought to be, “independent.” Supporters of the Fed, especially academic economists, join this chorus. Earlier generations of Fed leaders were more realistic. They spoke of the Fed as “independent within the government”—that is, not really independent. In this context, we may recall that the original Federal Reserve Act made the Secretary of the Treasury automatically the Chairman of the Federal Reserve Board.

“Independent” might mean independent of the U.S. Treasury, so that the Treasury cannot require the Fed to print up money to finance its deficits. However, the Fed has had significant experience as the willing servant of the Treasury. This was especially prominent during wars, such as when the Fed committed to buy however many long-term Treasury bonds it took to keep their yield down to 2.5% during World War II. Similarly, the Fed’s “quantitative easing” artificially lowered the cost of financing Treasury deficits for years. In financial crises, as it did in the Covid crisis, the Fed works hand in glove with the Treasury to finance bailouts.

Alternately, “independent” might mean independent of the Congress. In this sense, the Fed should not be independent. As a matter of fundamental government design, it should be in a system of effective checks and balances to which the Congress is essential. 

Since the original Federal Reserve Act in 1913, there have many amendments to the act, with notable Federal Reserve reform legislation in the 1930s and in 1977–78. After its unprecedented actions in the twenty-first century so far, I suggest that it is time again for serious reform of the Federal Reserve.

Reforming the Fed

With the foregoing problems in mind, I recommend eight specific reforms to promote responsibility to the elected representatives of the people in a system of Constitutional checks and balances, bring greater emphasis on genuine price stability, and align expectations with the realities of limited knowledge and pervasive uncertainty.

1. First and foremost, the Congress should amend the Federal Reserve Act to make it clear that the Fed does not have the authority unilaterally to decide on the nature of U.S. money, an essential public question. The revised act should provide that the maintaining or setting of any “inflation target” requires review and approval by Congress. This would make it consistent with the practice of other democratic countries, notably the father of the inflation targeting theory, New Zealand, where the inflation target has to be an agreement between the central bank and the parliamentary government. The original New Zealand target was zero to 2%. But no long-term target for depreciating the money the government provides and imposes on the people should be set without legislative approval.

A true public discussion of the “Money Question,” as they called it in the long debates that ultimately gave birth to the Federal Reserve, would be salutary.

In contrast to those historic debates, how in the world did the Fed imagine that it had the authority all on its own to commit the nation to perpetual inflation and perpetual depreciation of the currency at some rate of its own choosing? A new reform would straighten it out on that, establishing that the Fed is not a committee of independent economic philosopher-kings, but “independent within the government,” subject to the checks and balances reflecting a constitutional republic.

2. Consistent with the first reform, the Congress should cancel the 2% inflation target set unilaterally by the Fed until it has approved that or some other guidance. For better guidance, I recommend price stability, or a long-run average target inflation of approximately zero, cyclically varying in a range of perhaps -1% to +1%. This would be a modern form of “sound money.” A range is needed, because it is entirely unrealistic to think the inflation rate should be the same at all times, when every other economic factor is always changing. As an interim step, one could live with New Zealand’s original range of zero to 2%. 

3. From 1913 to 2008, the Fed’s investments in mortgages were exactly zero, reflecting the fundamental principle that the central bank should not use its monopoly money power to subsidize specific sectors or interests. The Fed’s buying mortgage securities was an emergency action in a housing finance crisis that has now been over for more than a decade. Its mortgage investments should go back to zero. The Fed made itself into the world’s biggest savings and loan; its mortgage portfolio totaled $2.5 trillion in August 2023. So the run-off will take a long time, but the Fed’s mortgage investments should finally go to zero and stay there, at least until the next mortgage finance crisis.

4. The fundamental structure of the Fed’s consolidated balance sheet, and the balance sheets of the 12 individual Federal Reserve Banks, should be reviewed by Congress, including their capitalization. An iron principle of accounting is that operating losses are subtracted from retained earnings and therefore from capital. Unbelievably, the Fed’s accounting does not follow this principle, but embarrassingly pretends that its operating cash losses are an intangible asset. This is in order to avoid reporting its true capital. Properly measured, using GAAP, at the end of August 2023, the Fed’s consolidated capital was negative $52 billion.

All Federal Reserve member banks have bought only one-half of the Fed stock to which they have subscribed, and the other half is callable at any time by the Federal Reserve Board. The Fed could raise $36 billion in new capital by issuing a call for the other half. It should do this, with due notice, to bolster the depleted or exhausted capital of the various Federal Reserve Banks.

In addition, the Fed is authorized by the Federal Reserve Act to assess the member bank shareholders up to 6% of the member’s own capital and surplus to offset Federal Reserve Bank losses. Since these losses otherwise become costs to the taxpayers, the Fed should discuss with Congress whether it should proceed to make such assessments.

5. The Fed should be required to use standard U.S. GAAP accounting in reporting its capital. It would not have to go as far as the Central Bank of Switzerland, which by law reports its earnings and capital on a mark-to-market basis, making its earnings and capital reflect the realities of market prices. The Fed’s mark-to-market loss as of June 2023 is over $1 trillion. Recognizing the Fed’s argument that these are “paper losses,” the Fed could continue to disclose them but not book them into capital. However, operating cash losses like the Fed is experiencing without question reduce capital and the Fed should be instructed to adopt GAAP in this respect. As Bishop Joseph Butler said, “Things and actions are what they are. … Why then should we desire to be deceived?”

 6. Dividends on Fed stock should be paid only out of Federal Reserve Bank profits. The Federal Reserve Banks pay attractive dividends, defined by the Federal Reserve Act, to their member bank shareholders: 6% dividends to small banks and the 10-year Treasury note rate, now over 4%, to larger banks. This is fine as long as the Fed is making money, but, as is little known, the act does not require profits to pay dividends and also makes the dividends cumulative, so they have to be paid, now or in the future. These statutory provisions obviously never contemplated that the Federal Reserve would someday be making gigantic losses. If Federal Reserve Banks have lost so much money that they have negative retained earnings, let alone negative total capital, they should not be paying dividends, and any dividends should not be cumulative. Otherwise, such dividends are being paid in effect by the taxpayers. 

7. Congress should revoke the Fed’s payment of the expenses of the Consumer Financial Protection Bureau. When the Fed is losing more than $100 billion a year, it is ridiculous for it to be paying over $700 million a year in the expenses of an unrelated entity for which it has no management responsibility. Far worse than ridiculous, it is against the Constitutional structure of the U.S. government, depriving Congress of its essential power of the purse. This issue may be decided by the Supreme Court in a current case involving whether the CFPB’s funding by the Fed violates the U.S. Constitution. It seems obvious to many of us that it does, and that whatever amount of money the Congress wants to spend on the Consumer Financial Protection Bureau, it ought to be appropriated in the normal way.

8. In general and throughout all considerations of the Federal Reserve, all parties, including the Congress and the Fed itself, should be realistic about the inherent inability of the Fed to reliably forecast the economic or financial future or to “manage the economy” or to know what the results of its own actions will be. In the memorable phrase of F. A. Hayek’s Nobel Prize Lecture, there should be no “pretense of knowledge” about central banking.

These proposed reforms reflect the lessons of the Federal Reserve’s eventful twenty-first-century career so far. As it heads for its 110th birthday, they would move the Fed, with its power and with its danger, toward operating more effectively in the context of our Constitutional republic.

Federalist Society Event: October 2nd: How Risky Are the Banks Now? What Regulatory Reforms Make Sense?

Hosted by the Federalist Society. RSVP to attend virtually.

October 2, 2023 at 1:00 PM ET

Six months ago, we experienced bank runs and three of the four largest bank failures in U.S. history. Regulators declared there was “systemic risk” and provided bailouts for large, uninsured depositors. What is the current situation? While things seem calmer now, what are the continuing risks in the banking sector? Banks face huge mark-to-market losses on their fixed-rate assets, and serious looming problems in commercial real estate. How might banks fare in an environment of higher interest rates over an extended period, or in a recession? Reform ideas include a 1,000-page “Basel Endgame” capital regulation proposal. Which reforms make the most sense and which proposals don’t? Our expert and deeply experienced panel will take up these questions and provide their own recommendations in their signature lively manner.

RSVP to attend virtually.

PANELISTS

William M. Isaac - Chairman, Secura/Isaac Group

Keith Noreika - Executive VP & Chairman, Banking Supervision & Regulation Group, Patomak Global Partners

Lawrence J. White - Robert Kavesh Professorship in Economics, Leonard N. Stern School of Business, New York University

MODERATOR

Alex J. Pollock - Senior Fellow, Mises Institute

The Illusion of Control: Unmasking the Federal Reserve with Alex J. Pollock

Hosted by The Rational Egoist.

In this compelling episode of "The Rational Egoist," host Michael Leibowitz sits down with Alex J. Pollock, a senior fellow at The Mises Institute and former Principal Deputy Director of the Office of Financial Research in the U.S. Treasury Dept. Together, they delve into the fascinating yet fraught world of the Federal Reserve, an institution often misconceived as a central economic manager.

The Federal Reserve, in its simplest form, comprises 12 regional banks attempting to regulate the U.S. economy. Its original mandate was to inject liquidity into the financial system during times of crisis. However, as Michael and Alex point out, the persistent and unrestrained expansion of money supply even after crises have been resolved has converted this mechanism into an ongoing problem, rather than a solution.

The conversation takes a historical turn when they discuss the U.S. government's suppression of the gold standard and its unilateral ban on citizens owning gold. Remarkably, while American civilians were barred from gold ownership, the U.S. government continued to accumulate large reserves of gold by purchasing it overseas.But the real kicker comes when our experts examine the ramifications of divorcing the U.S. dollar from gold in 1971. This shift has led to a monetary system with virtually no constraints on the amount of currency that can be printed, setting the stage for escalating inflation and subsequently, complex political challenges.

Despite its numerous failings, the power of the Federal Reserve continues to grow, becoming increasingly centralised. The paradox is as disconcerting as it is true: the more mistakes the Federal Reserve makes, the more potent it becomes.

Join Michael and Alex as they unravel these complicated threads, offering keen insights into an institution whose influence stretches far and wide but whose true impact remains poorly understood. This episode is not just an analysis but a cautionary tale, highlighting the perils of placing too much power in the hands of a single entity.

Listen to the podcast here.

Lots of Red Ink at the Fed

Published by the Mises Institute and RealClear Markets.

The Federal Reserve has officially reported a loss of $57 billion for the first six months of 2023. Quite a number! So the “Federal Reserve Banks Combined Quarterly Financial Report as of June 30, 2023” (CQFR)—a little-known document—is especially notable for its red ink. We can anticipate an annual loss of over $100 billion for 2023 and for the losses to continue into 2024. 1

How does a central bank, especially the world’s greatest and most important central bank, lose tens of billions of dollars in six months? An average person, influenced by the mystique of the Fed, might understandably be baffled by this fact.

To understand what is happening, we need to recall that in addition to being a media star as the manipulator of the world’s dominant currency, the Federal Reserve is a bank—well, actually 12 Federal Reserve Banks (FRBs), covering districts across the United States. Added together they are huge, with total assets of $8.3 trillion (with a T). The FRBs have loans, investments, deposits and borrowings, interest income and interest expense, and profit or loss like other banks do. They also have private shareholders: the commercial banks which are “Fed member banks,” and the FRBs have over them the Washington Federal Reserve Board, which charges them for its expenses.

The combined FRBs are intended to always be profitable because of their unique monopoly in issuing U.S. dollar paper currency. This is a very lucrative privilege which means together they have $2.3 trillion of zero interest cost funding from the dollar bills circulating around the country and the world, which they can invest in interest earning assets. (They print up some money and use it to buy Treasury bonds, simply said.) But instead of making profits, as the combined Fed reliably did for more than 100 years, it is now making giant losses, a historic reversal.

The CQFR shows that in the first six months of 2023 the combined Fed had $88 billion in interest income, but $141 billion in interest expense. So it paid out in interest $53 billion more than it received, and also had to pay its overhead expenses of over $4 billion. 

Why doesn’t it have more interest income? Because the Fed engaged to the tune of about $5 trillion in one of the most classic of financial risks: borrowing short and lending long, and now interest rates have gone very far against it and the risk has turned into real losses. 

The CQFR shows on page 22 that on June 30 the combined Fed owned $5.5 trillion in Treasury Securities with an average yield of 1.96%, and $2.6 trillion of mortgage-backed securities yielding on average 2.20%. In short, it invested in massive amounts of very long-term fixed rate assets and locked in for years a historically low yield of about 2%. Meanwhile, it was funding $5 trillion of these assets with floating rate deposits from banks and borrowings in the form of repurchase agreements, the cost of which rose to over 5%.

You don’t need a degree in banking or a Ph.D. in economics to know that lending money at 2% while you are borrowing money at 5% is a losing proposition. That is what our Federal Reserve Banks did and continue to do.

On top of this, as disclosed in the footnotes of the CQFR on page 7, when the combined Fed’s investments were marked to market on June 30, they had a market value loss of over $1 trillion, or a market value loss of 23 times the Fed’s stated capital.

The CQFR reports a total capital of about $42 billion ($35.6 billion of paid-in capital from the member commercial banks and $6.8 billion of retained earnings, called “surplus”). But note: This total capital is much less than the $57 billion reported loss for the six months of 2023, to which must be added the loss for the later months of 2022 of $17 billion. This total $74 billion of accumulated losses by June 30 must be subtracted from the retained earnings and thus from total capital. But the Fed does not do this—it misleadingly books its losses as an asset (!), which it calls a “deferred asset”-- a practice highly surprising to anyone who passed Accounting 101. Why does the Fed do this? Presumably it does not wish to show itself with negative capital. However, negative capital is the reality.

Here are the combined Fed’s correct capital accounts as of June 30, based on Generally Accepted Accounting Principles. They result in a capital of negative $32 billion:

Paid-in capital            $36 billion

Retained earnings   ($68 billion)

Total capital               ($32 billion)

The Fed wants you to believe that neither its negative capital nor its giant losses matter because it is the Fed and can print money. Many economists agree.

But does it matter that the Fed’s losses will cost not only it, but also the Treasury and the taxpayers, over $100 billion this year and more in the future? Does it matter that on a combined basis its accumulated losses are greater than its private stockholders’ paid-in capital? Does it matter that with negative equity under standard accounting, it is technically insolvent? All of these can be debated, but the numbers certainly do get one’s attention.

We conclude with a simple question: Did the leaders of the Fed intend to lose $57 billion in six months? Did they intend to be looking at a loss of more than $100 billion for this year? Did they intend to have a mark to market loss of more than $1 trillion? It is impossible to believe they did. The liberal supply of red ink they have delivered certainly does not help the Fed’s reputation for knowing what it is doing.

The New Bank Bailout

Taxpayers are covering Federal Reserve losses, for which member banks are supposed to be liable.

Published in the Wall Street Journal with Paul H. Kupiec.

Taxpayers are bailing out Federal Reserve member banks—institutions that own the stock of the Fed’s 12 district banks—and hardly anyone has noticed. For more than 100 years, our central-banking system has made a profit and reliably remitted funds to the U.S. Treasury. Those days are gone. Sharp rate hikes have made the interest the Fed pays on its deposits and borrowing much higher than the yield it receives on its trillions in long-term investments. Since September 2022, its expenses have greatly exceeded its interest earnings. It has accumulated nearly $93 billion in cash operating losses and made no such remittances.

The Fed is able to assess member banks for these losses, but it has instead borrowed to fund them, shifting the bill to taxpayers by raising the consolidated federal debt. That tab is growing larger by the week. Under generally accepted accounting principles, the Fed has $86 billion in negative retained earnings, bringing its total capital to around negative $50 billion.

Each of the Fed’s 12 district banks, except Atlanta, has suffered large operating losses. Accumulated operating losses in the New York, Chicago, Dallas and Richmond, Va., district banks have more than consumed their capital, making each deeply insolvent. A fifth district bank, Boston, is teetering on insolvency. At the current rate of loss, five others will face insolvency within a year and the taxpayers’ bill will grow by more than $9 billion a month until interest rates decline or the Fed imposes a capital call or assessments on its member banks.

The Federal Reserve Act requires that member banks subscribe to the shares issued by their district bank in a dollar value equal to 6% of a member institution’s “capital” and “surplus”—the definitions of which depend on the depository institution’s charter. Member banks must pay for half their subscribed shares, while the remaining half of the subscription is subject to call by the board.

The act empowers the Fed to compel member banks to contribute additional funds to cover their district reserve bank operating losses up to an amount equal to the value of their membership subscription. The provision reads: “The shareholders of every Federal reserve bank shall be held individually responsible, equally and ratably, and not one for another, for all contracts, debts, and engagements of such bank to the extent of the amount subscriptions to such stock at the par value thereof in addition to the amount subscribed, whether such subscriptions have been paid up in whole or in part” (emphasis added).

In the century when district banks were reliably profitable, these provisions posed only a remote risk to Fed shareholders. The central bank didn’t need member banks to make any additional contributions. As district banks’ consolidated losses approach $100 billion, however, the risks to Fed stockholders have risen. If called on, member banks are legally responsible to make these payments. At a minimum, they should disclose this potential liability.

The risk is that the more than 1,400 Fed-shareholder banks could receive a call on their resources equal to as much as 9% of their capital and surplus—a call for a 3% additional equity investment and 6% cash payment to offset district bank losses. Member banks could be on the hook to contribute three times the capital they currently own in their district bank, or $108 billion in total for the central-bank system.

The Securities and Exchange Commission requires every registered firm to include in its annual 10K reports “an explanation of its off-balance sheet arrangements.” The provision applies to securities issued by banks and bank holding companies that are traded on national exchanges, but enforcement is delegated to the federal regulatory agencies that aren’t requiring Fed member banks and their holding companies to disclose the Fed’s contingent resource claim as a material risk or as a contingent liability.

Consider the Goldman Sachs Group, which includes at least two Fed member banks. The company’s 10K for 2022 includes page after page devoted to discussion of the group’s regulatory, market, competition, operational, sustainability and climate-change risks. Not included in that list is the risk of being compelled to recapitalize and share in the losses of its Fed district banks.

The larger of the two is a member of the New York Federal Reserve Bank, a district bank with accumulated losses of nearly $62 billion, or more than four times its $15 billion stated capital. A smaller Goldman Sachs Trust bank is a member of the Philadelphia Fed, a bank with $821 million in accumulated losses.

Goldman’s member banks had almost $44 billion in capital and surplus, according to our analysis of its June regulatory-call report data. Applying the 3% equity-investment and 6% cash-payment requirements, we calculate that Goldman would face a maximum contingent call of approximately $4 billion—a sum that would exceed the combined 2022 income of its two Fed member banks.

Those sums aren’t mere rounding errors, and they shouldn’t be placed on taxpayers’ tab. Federal bank regulators should require Fed member banks that are registered with the SEC and their holding companies to disclose their risks of being called on to prop up the finances of their Federal Reserve district banks.

WKXL: Facing The Future: Will We Learn the Necessary Lessons from Past Economic Crises?

Published in WKXL:

This week on Facing the Future, we revisit a conversation from earlier this year with Alex Pollock and Howard Adler, authors of a new book entitled “Surprised Again: The COVID Crisis and the New Market Bubble.” The book examines the recent economic crises, including the COVID related economic shutdown and the Great Recession of 2008-10, and asks why these types of events always seem to take us by surprise.

Though inflation has come down somewhat from its peak in the last year, it is still a problem for our economy, brought about in large part by the federal government’s responses to the two most recent economic crises. Not to mention the trillions of dollars these crisis responses added to our national debt.

WKXL - NH Talk Radio · Facing The Future: Will We Learn the Necessary Lessons from Past Economic Crises?

The Fed Is Losing Tens of Billions: How Are Individual Federal Reserve Banks Doing?

Published in the Mises Institute with Daniel J. Semelsberger. Also published in RealClear Markets.

The Federal Reserve System as of the end of July 2023 has accumulated operating losses of $83 billion and, with proper, generally accepted accounting principles applied, its consolidated retained earnings are negative $76 billion, and its total capital negative $40 billion. But the System is made up of 12 individual Federal Reserve Banks (FRBs).1 Each is a separate corporation with its own shareholders, board of directors, management and financial statements. The commercial banks that are the shareholders of the Fed actually own shares in the particular FRB of which they are a member, and receive dividends from that FRB. As the System in total puts up shockingly bad numbers, the financial situations of the individual FRBs are seldom, if ever, mentioned. In this article we explore how the individual FRBs are doing.

All 12 FRBs have net accumulated operating losses, but the individual FRB losses range from huge in New York and really big in Richmond and Chicago to almost breakeven in Atlanta. Seven FRBs have accumulated losses of more than $1 billion. The accumulated losses of each FRB as of July 26, 2023 are shown in Table 1.

Table 1: Accumulated Operating Losses of Individual Federal Reserve Banks [2]

New York ($55.5 billion)

Richmond ($11.2 billion )

Chicago ( $6.6 billion )

San Francisco ( $2.6 billion )

Cleveland ( $2.5 billion )

Boston ( $1.6 billion )

Dallas ( $1.4 billion )

Philadelphia ($688 million)

Kansas City ($295 million )

Minneapolis ($151 million )

St. Louis ($109 million )

Atlanta ($ 13 million )

The FRBs are of very different sizes. The FRB of New York, for example, has total assets of about half of the entire Federal Reserve System. In other words, it is as big as the other 11 FRBs put together, by far first among equals. The smallest FRB, Minneapolis, has assets of less than 2% of New York. To adjust for the differences in size, Table 2 shows the accumulated losses as a percent of the total capital of each FRB, answering the question, “What percent of its capital has each FRB lost through July 2023?” There is wide variation among the FRBs. It can be seen that New York is also first, the booby prize, in this measure, while Chicago is a notable second, both having already lost more than three times their capital. Two additional FRBs have lost more than 100% of their capital, four others more than half their capital so far, and two nearly half. Two remain relatively untouched.

Table 2: Accumulated Losses as a Percent of Total Capital of Individual FRBs [3]

New York 373%

Chicago 327%

Dallas 159%

Richmond 133%

Boston 87%

Kansas City 64%

Cleveland 56%

Minneapolis 56%

San Francisco 48%

Philadelphia 46%

St. Louis 11%

Atlanta 1%

Thanks to statutory formulas written by a Congress unable to imagine that the Federal Reserve could ever lose money, let alone lose massive amounts of money, the FRBs maintained only small amounts of retained earnings, only about 16% of their total capital. From the percentages in Table 2 compared to 16%, it may be readily observed that the losses have consumed far more than the retained earnings in all but two FRBs. The GAAP accounting principle to be applied is that operating losses are a subtraction from retained earnings. Unbelievably, the Federal Reserve claims that its losses are instead an intangible asset. But keeping books of the Federal Reserve properly, 10 of the FRBs now have negative retained earnings, so nothing left to pay out in dividends.

On orthodox principles, then, 10 of the 12 FRBs would not be paying dividends to their shareholders. But they continue to do so. Should they?

Much more striking than negative retained earnings is negative total capital. As stated above, properly accounted for, the Federal Reserve in the aggregate has negative capital of $40 billion as of July 2023. This capital deficit is growing at the rate of about $ 2 billion a week, or over $100 billion a year. The Fed urgently wants you to believe that its negative capital does not matter. Whether it does or what negative capital means to the credibility of a central bank can be debated, but the big negative number is there. It is unevenly divided among the individual FRBs, however.

With proper accounting, as is also apparent from Table 2, four of the FRBs already have negative total capital. Their negative capital in dollars shown in Table 3.

Table 3: Federal Reserve Banks with Negative Capital as of July 2023 [4]

New York ($40.7 billion)

Chicago ($ 4.6 billion )

Richmond ($ 2.8 billion )

Dallas ($514 million )

In these cases, we may even more pointedly ask: With negative capital, why are these banks paying dividends?

In six other FRBs, their already shrunken capital keeps on being depleted by continuing losses. At the current rate, they will have negative capital within a year, and in 2024 will face the same fundamental question.

What explains the notable differences among the various FRBs in the extent of their losses and the damage to their capital? The answer is the large difference in the advantage the various FRBs enjoy by issuing paper currency or dollar bills, formally called “Federal Reserve Notes.” Every dollar bill is issued by and is a liability of a particular FRB, and the FRBs differ widely in the proportion of their balance sheet funded by paper currency.

The zero-interest cost funding provided by Federal Reserve Notes reduces the need for interest-bearing funding. All FRBs are invested in billions of long-term fixed-rate bonds and mortgage securities yielding approximately 2%, while they all pay over 5% for their deposits and borrowed funds—a surefire formula for losing money. But they pay 5% on smaller amounts if they have more zero-cost paper money funding their bank. In general, more paper currency financing reduces an FRB’s operating loss, and a smaller proportion of Federal Reserve Notes in its balance sheet increases its loss. The wide range of Federal Reserve Notes as a percent of various FRBs’ total liabilities, a key factor in Atlanta’s small accumulated losses and New York’s huge ones, is shown in Table 4.

Table 4: Federal Reserve Notes Outstanding as a Percent of Total Liabilities [5]

Atlanta 64%

St. Louis 60%

Minneapolis 58%

Dallas 51%

Kansas City 50%

Boston 45%

Philadelphia 44%

San Francisco 39%

Cleveland 38%

Chicago 26%

Richmond 23%

New York 17%

The Federal Reserve System was originally conceived not as a unitary central bank, but as 12 regional reserve banks. It has evolved a long way toward being a unitary organization since then, but there are still 12 different banks, with different balance sheets, different shareholders, different losses, and different depletion or exhaustion of their capital. Should it make a difference to a member bank shareholder which particular FRB it owns stock in? The authors of the Federal Reserve Act thought so. Do you?

______________

1. In order of their district numbers, which go from east to west, the 12 FRBs are Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco.

2. Federal Reserve H.4.1 Release, July 27, 2023

3. Our calculations based on the July 27 H.4.1 Release.

4. Ibid.

5. Ibid.

Sept 21: AEI Event: Has the Fed Produced a Soft Economic Landing?

Hosted by the American Enterprise Institute (AEI).

A video livestream will be available on this page starting at 2:00 PM on Thursday, September 21st. Please scroll down to view.

Contact Information

Event: Beatrice Lee | Beatrice.Lee@aei.org
Media: MediaServices@aei.org | 202.862.5829

RSVP to Watch Online

Over the past year, US headline inflation has declined from a peak of over 9 percent to 3 percent. At around 3.5 percent, unemployment has remained close to a postwar low, while the Federal Reserve has moved away from its earlier zero interest rate policy to the most aggressive tightening cycle in the past 40 years.

Our expert panel will discuss whether the Fed has succeeded in producing a soft economic landing and will examine the remaining risks to the economy and the financial system.

Submit questions to Beatrice.Lee@aei.org or on Twitter with #AskAEIEcon.

Agenda

2:00 p.m.
Introduction:
Desmond Lachman, Senior Fellow, AEI

2:05 p.m.
Panel Discussion:

Panelists:
Donald Kohn, Robert V. Roosa Chair in International Economics, Brookings Institution
Desmond Lachman, Senior Fellow, AEI
Kevin Warsh, Shepard Family Distinguished Visiting Fellow, Hoover Institute
William White, Senior Fellow, C.D. Howe Institute

Moderator:
Alex J. Pollock, Senior Fellow, Mises Institute

3:30 p.m.
Q&A

4:00 p.m.
Adjournment

Rsvp here.

Will the Fed take the medicine one of its presidents prescribes for other banks?

Published in The Hill.

The president of the Federal Reserve Bank of Minneapolis, Neel Kashkari, like an old doctor for ailing banks, recently prescribed a stern regimen for those in weakened conditions from big mark-to-market losses on their long-term investments and loans. Speaking at a National Bureau of Economic Research panel this month, Kashkari pointedly asked: 

“What can a bank do that is already facing large mark-to-market losses?” 

An excellent and hard question, for the losses have already happened, economically speaking. Of course, these banks can passively hold on and hope that interest rates will go back down to their historic lows, and hope that depositors will stop demanding higher yields or departing elsewhere. 

Besides hoping, what can they do?

Doctor Kashkari unsympathetically reviewed the possible medicines, all bitter. These, he said, were three: 

1. Try to raise more equity. 

2. Sell the underwater assets. 

3. Cut dividends. 

Considering these options, Kashkari observed that raising equity may not be so easy or attractive, since investors may not be inclined to invest in funding losses. Divesting the underwater assets by definition means selling at a loss, so the unrealized losses become realized losses on the accounting books.  This perhaps would render the bank formally undercapitalized or worse and may frighten large depositors — will they run?

The third option of cutting dividends then appears as the most practical way to conserve some capital, but as Kashkari asked rhetorically, how many bank CEOs are likely to want to cut their dividends? So he proposed new stress tests with high-interest rates, which would lead to restricting the dividends by regulatory order.

Physician, Heal Thyself! 

Kashkari did not mention that the biggest bank in the country, the one he works for, is facing particularly large mark-to-market losses. The $8 trillion Federal Reserve has net mark-to-market loss of $911 billion as of its last report on March 31. This mark-to-market loss is a remarkable 21 times its total capital of $42 billion. Moreover, according to my calculations, the Fed appears to be heading for an operating loss of about $110 billion for the year 2023. 

So it is timely and appropriate to apply “Doctor” Kashkari’s three possible medicines to the Federal Reserve itself.  

1. The Fed is clearly in a position to raise more equity in the face of its losses if it chooses to. All the commercial bank members of the Federal Reserve are required to subscribe to stock in the Federal Reserve according to a formula based on their own capital, but they all have bought only half of their required subscriptions. The Fed has the right to call for the purchase of the other half at its discretion. It could issue that call right now, and double its paid-in capital. But will it?   

1. The Fed could obviously sell some of its underwater investments. But just as for other banks, that would turn unrealized losses into realized losses and make the Fed’s existing accounting losses even bigger. As the leading investor in mortgage-backed and long-term Treasury securities, large sales by the Fed could move market prices downward, increasing its mark-to-market losses on the remaining investments. Although it has produced projections of realizing losses by sales of underwater investments, the Fed, like the banks Kashkari discussed, chooses not to sell. 

1. How about dividends then? The Fed is paying rich dividends of 6 percent to small banks and the 10-year Treasury yield to large banks while it is running an estimated annual loss of about $110 billion, has a $911 billion mark to market loss, and properly accounted for per my calculations, has negative capital of $38 billion, which is getting more negative each week. It is borrowing money to pay its dividends. And what would a high interest rate stress test applied to the Fed’s massive interest rate risk show? Should the Fed take Kashkari’s dividend medicine and restrict or skip its dividends in light of its huge losses? Revising Kashkari’s rhetorical question, how many Federal Reserve presidents and governors want to do that, including the president of the Federal Reserve Bank of Minneapolis? 

As that president explained, when you already have large economic losses, none of the options are appetizing. 

Letter: Fed at the forefront of inflation-driven losses

Published in the Financial Times.

Martin Wolf (“Inflation’s return changes the world”, Opinion, July 5) rightly points out the “further problems . . . as losses build up in institutions most exposed to property, interest rate and maturity risks.”

He does not mention that the institution with the biggest losses of all from interest rate risk, the one most changed by inflation’s return, is none other than the world’s leading central bank. In the past nine months, the Federal Reserve has suffered previously unimaginable operating losses of $74bn from its deeply underwater interest rate risk position, a loss which far exceeds its total capital of $42bn. In misleading and arguably fraudulent accounting, the Fed refuses to reduce its reported capital by these losses; with proper bookkeeping, it would now be reporting capital of negative $32bn, growing more negative every month. It insists that no one should care about its negative capital, but carefully cooks the books to avoid reporting it.

The Fed is on the way to operating losses of an estimated $110bn this year. Its mark to market loss as of March 31 2023 was $911bn. The Fed has no possibility of generating offsetting gains from revaluing gold, since it owns exactly zero gold. Wolf reasonably asks if “economies must be kept permanently feeble in order to stop the financial sector from blowing them up”. We can likewise ask, “Must central banks make themselves so feeble in order to prop up economies and the financial sector?”

Will the Fed Ever Relinquish Its New Powers?: The Fed's "Cincinnatian Problem"

Published by the Mises Institute. See the PDF here.

In times of banking and financial crises, central banks always intervene. This is not a law of nature, but it is an empirical law of central bank behavior. The Federal Reserve was created 110 years ago specifically to address banking panics by expanding money and credit when needed, by providing what was called in the Federal Reserve Act of 1913 an “elastic currency,” so it could make loans in otherwise illiquid markets, when private institutions can’t or won’t.

The great Victorian banking thinker (as well as private banker) Walter Bagehot proposed that the Bank of England “lend freely” to quell a panic, and the central banks of the world today are all his disciples in this respect. With the post–Bretton Woods, pure-fiat-currency Federal Reserve, the US currency is elastic with a vengeance. That’s how we got a Fed with assets of $3 trillion during the great real estate bust of 2007–12 and then the truly remarkable $8.9 trillion Fed balance sheet in the wake of the covid financial crisis of 2020.

Austrian economists are generally against any central bank intervention at all, but suppose with me arguendo that the case for intervention in a crisis prevails: that the periodic financial crises that do and doubtless will continue to occur should be addressed by the temporary expansion of the compact power and money-printing ability of the government and its central bank—especially the money-printing power, which shifts assets and risks to the government’s balance sheet. The central bank’s balance sheet thus expands to offset the pressured private balance sheets. Even if the crisis was caused by the actions of the central bank itself, as Austrians would point out, and even though the expansion creates moral hazard for the future, the central bank’s elastic currency and balance sheet are handy in midst of the crisis. This is the credo of all modern central banks.

But what happens when the crisis is over?

Note well the essential word temporary in the preceding argument for crisis intervention. The crisis interventions should be temporary. If prolonged, they will tend more toward monopoly and bureaucracy and less toward innovation, growth, and economic well-being than will competitive, enterprising markets. In the extreme, long-term intervention will produce markets characterized by socialist stagnation. How do you get interventions withdrawn when the crisis is over?

Consider a huge and radical intervention of the last fifteen years. The Federal Reserve started buying mortgage securities at the beginning of 2009. The amount of mortgage securities which had been owned by the Federal Reserve until then, from 1913 to 2008, was exactly zero. Then, faced with the shriveling of the vast housing bubble and the panic of 2008, the Fed was led by Chairman Ben Bernanke into a new intervention and started buying mortgage securities to prop up house prices and the housing finance market. This was the opposite of the former Fed orthodoxy, which held that the monetary power of the central bank should not be used to favor any particular economic sector.

Bernanke’s theory was that this radical intervention would be temporary. As he testified before Congress in February 2011: “What we are doing here is a temporary measure which will be reversed so that at the end of the process, the money supply will be normalized, the amount of the Fed’s balance sheet will be normalized, and there will be no permanent increase, either in money outstanding, in the Fed’s balance sheet, or in inflation” (Italics added).

Needless to say, the promised normalization didn’t happen. As of the end of April 2023, the Fed owns $2.6 trillion of mortgage securities. That is larger than what the total assets of the Fed were at the end of 2008. That number and the interest rate risk it represents would have astonished previous generations of Federal Reserve governors. The Fed also experienced a massive mark to market loss on these mortgage securities: a loss of $408 billion as of the end of 2022, or almost ten times the Fed’s total capital of $42 billion.

In the intervening years, the Fed’s mortgage purchases, driving down mortgage interest rates to an unprecedented less than 3 percent, stoked a major house price inflation. By 2021, US national house prices were in a new bubble, their increase rising to an annual rate of over 16 percent. Faced with runaway inflation of house prices, the Fed has unbelievably continued to buy hundreds of billions of dollars of mortgage securities, and never sells any. I know of no one who now defends this far overextended intervention.

In my view, the Federal Reserve should get out of the business of pushing up house prices, and the Fed’s mortgage portfolio should go back to the normal amount of exactly zero.

Emergency interventions, however sincere the original intent that they be temporary, inevitably build up political and economic constituencies who profit from them and want their continuation. When the central bank monetizes government debt, the biggest such constituent is the government itself.

So here is our essential and unsolved problem: How do you reverse the central bank emergency programs, originally thought and meant to be temporary, after the crisis has passed? No one has successfully addressed the issue of how to do this—not even central banking’s most ardent supporters propose an answer.

That the emergency interventions of the crisis should be withdrawn in the normal times which follow I call the Cincinnatian doctrine. The name comes from the ancient Roman hero Cincinnatus, who was called from his plow to save the state and made temporary dictator of Rome. He did save the state, and then, mission accomplished, eft his dictatorship and went back to his farm. Similarly, two millennia later, George Washington, the victorious general and hero who had saved the United States and might perhaps have made himself king, voluntarily resigned his commission and went back to his farm, becoming to the eighteenth century “the modern Cincinnatus.”

But the Federal Reserve does not have the republican virtue of Cincinnatus or Washington, so how do we get the Fed to go back to its farm? The difficulty of ending vast emergency interventions whose day has passed but which have become established and advantageous to their constituencies and have increased the power enjoyed by the central bankers is the Cincinnatian problem. There is no easy answer to the Cincinnatian problem. It deserves our intense focus.

July 3--Sympathy for Thomas Jefferson Day

Everybody knows about July 4, but what was happening on July 3, 1776?  On that day, the draft of the Declaration of Independence submitted by Thomas Jefferson was edited by the Continental Congress, meeting as a committee.  Jefferson had to sit there, “the writhing author,” says my well-worn history of the Declaration, while his words were criticized, deleted and altered.  Jefferson “was far less happy when his handiwork was subjected to what he called the ‘depredations’ of Congress.” He “kept silent for propriety’s sake,” but “in his opinion, they did a good deal of damage [as] the delegates took a hand in the drafting.”  

All those who have worked assiduously on their writing, then had it edited by a committee, will have lively sympathy for Jefferson every July 3!

The Congress “effected economy in words,”  “deleted unnecessary phrases,”  “eliminated the most extravagantly worded of all the charges [against King George],” “deleted a passage in which Scottish mercenaries were coupled with foreign [ones],” changed Jefferson’s final paragraph so as to include in it the precise language of the resolution of independence just adopted [on July 2]”, and “left out several moving phrases of his toward the end.”

I have reviewed the edits made by the Congress, and find that they definitely improved the final, world historical document.  Nonetheless, to sit there while your work suffers “depredations” by a committee of your colleagues, even if they are in fact improvements, is surely difficult.  Our sympathy for the author should be undiminished.

1. Dumas Malone, The Story of the Declaration of Independence, Oxford University Press, 1954.

U.S. banking problems: Mortgage interest rate risk strikes again

Published in Housing Finance International.

Notable U.S. bank runs and failures in spring 2023 followed speeches from the Treasury Department and the Federal Reserve in 2022 and early 2023 about what a good shape the U.S. banking system was in. Of course, they wanted the non-bank financial companies (so-called “shadow banks”) to be regulated more, but they claimed the commercial banks were in great condition. This was thanks to the Dodd Frank Act and its greatly expanded regulation, it was suggested, and we could congratulate ourselves for this banking stability.

Surprise! Shortly thereafter came the second, third and fourth largest bank failures in U.S. history (First Republic, Silicon Valley, and Signature banks, respectively). These were accompanied by emergency government declarations that the failing banks were “systemically important”—in other words, that the banking system in general was at risk. Such declarations allowed bailouts of wealthy depositors who had accounts with the failing banks of far over the normal statutory maximum of $250,000 for government deposit insurance coverage. Those depositors should have taken a loss on the risky investments they had made and from their folly in maintaining hundreds of millions, in some cases, or even billions of dollars, in single small-enough-to-fail banks. That was quite unwise risk taking on their part, but big money venture capitalists, tech entrepreneurs and cryptocurrency barons, among others, got all their deposits back by being given other people’s money. The insurance fund of the Federal Deposit Insurance Corporation was reduced below its minimum statutory level by the cost of these failures.

Central to the failures were billions of dollars in losses resulting from investing in long-term, fixed rate mortgage securities and financing them with short-term, floating-rate liabilities. The interest rate risk of the American 30-year fixed-rate mortgage strikes again! Although these mortgages were often held in securitized form, making them theoretically liquid, once their market value was far below their cost, selling them would trigger the realization of the huge losses, which could and did set off a run on the bank. So just as in the case of the U.S. savings & loans in the 1980s, the shortfunded 30-year mortgages contributed to first massive interest rate risk and then fatal liquidity risk for the failed banks.

However, not only the failed banks, but hundreds of banks across the country have made this mistake. In doing so, they were following the Pied Piper of the Federal Reserve and its long lasting, but now ended, suppression of both short-term and long-term interest rates, its predictions of “lower interest rates for longer,” and quite remarkably, its own practice of investing trillions of dollars in long term fixed rate assets funded by borrowing short in its own balance sheet. Investing in long-term mortgages and also long-term Treasury securities, the banks and the Federal Reserve together created huge amounts of interest rate risk for the total banking system.

This is a classic banking risk, a classic banking mistake. Along with it comes a classic problem: although it is often said that bank runs reflect irrational fears, in fact runs are highly rational from the viewpoint of the depositor.

Keeping your money in a questionable bank instead of getting it out, when you can’t really know what the bank’s assets are worth or what is really going on inside it or who is lying, has no upside potential and large downside potential of serious losses on money you didn’t intend to be at risk at all. So, it is rational to run.

Every bank should be structured with the thought that runs are rational from the viewpoint of the depositors. This is an old and essential banking truth. As the great Walter Bagehot wrote in Lombard Street in 1873, “A banker, dealing with the money of others, and money payable on demand, must be always, as it were, looking behind him and seeing that he has reserve enough in store if payment should be asked for.” Bagehot adds, “Adventure is the life of commerce, but caution is the life of banking.”

One recent academic analysis has estimated the mark to market loss of all U.S. banks, including both their fixed-rate securities and fixed-rate loans, and concluded that the banking system has a mark to market loss of about $2 trillion on these assets. That’s $2 trillion.

In comparison, the book capital of the U.S. banking system is about $2.2 trillion, and of that $2.2 trillion, $400 billion are intangible assets. So, the tangible capital is approximately $1.8 trillion, while the mark to market loss may be something like $2 trillion. That would suggest that we have an entire banking system with something like zero real capital. While there is large variation among the 4,700 banks and savings associations, the overall situation is certainly sobering on a mark-to-market basis.

The way unrealized losses turn into real losses in financial institutions that have fixed rate, long term assets funded with short term floating rate liabilities, is that the cost of their liabilities goes dramatically up and the yield on their assets doesn’t.

The big question in the banking system has thus become: how resistant are the banks to the cost of their deposits rising to full market levels of 5% or so, in order to fund the deeply underwater fixed rate loans and securities on which there is a $2 trillion market value loss? How much is their interest cost going to rise? In other words, as the unrealized losses turn into greater interest expense, how much can you continue to cheat the savers in order to prop up the banks? What we will observe going forward is the contest between the inexorable rise in the funding cost, and the hope that banks can continue to cheat the savers and keep the deposit cost below market. This puts the banking regulators, who are in favor of bank safety, on the side of cheating the savers. All this is just like the U.S. savings & loans and their regulators in the 1970s and 1980s.

On top of its interest rate risk, we find out the U.S. banking system has, once again, a large risk exposure to troubled commercial real estate. Consider this observation: “The unfavorable conditions in banking were greatly aggravated by the collapse of unwise speculation in real estate.” That is from the report of the U.S. Comptroller of the Currency in 1891. Little about this connection has changed since then.

The famous Fed Chairman Paul Volcker observed that “There are no new problems in banking, only new people.”

But why do crises keep recurring if we have comprehensive regulation, like the Dodd Frank Act and its thousands of pages of implementing regulations? The banking scholar, Bernard Shull, insightfully wrote, “Comprehensive banking reform, traditionally including augmented and improved supervision, has typically evoked a transcendent, and in retrospect, unwarranted optimism.”Writing in the 1990s, Shull continued, “Confronting the S&L disaster with yet another comprehensive reform, the Secretary of the Treasury proclaimed ‘Two watchwords guided us as we undertook to solve this problem. Never again.’”

That was the savings & loan reform of 1989, and then came the banking reforms of 1991, and the housing finance reforms of 1992. But in the following decade, instead of “never again,” another massive crisis happened again anyway. Then after that 2007-09 crisis, comprehensive reform was once again debated with the political result of the Dodd Frank Act. But another decade or so later, once again we have bank runs and failures.

We are up against the reality of the politics of banking and finance. All finance is political, especially housing finance. No matter how we politically organize any bank regulation, it will over time have to be reorganized, because the perfect answer does not exist. Whenever we try to engineer and control human behavior, the attempts at control themselves induce unexpected adaptations and reactions in the behavior of financial markets, and also in the behavior of the regulators and politicians themselves. Hence, as we observe historically, every reform requires another reform to address the unexpected results and failures of the prior reform, and so on, ad infinitum. The current troubles are part of the ongoing crisis of 2020. Starting in 2020, we experienced the Covid crisis, the financial panic, the sharp economic contraction, the vast expansion of money printing and government expenses in response, the following bubble markets, the everything bubble, the runaway inflation, the correction with rising interest rates, the deflation of the everything bubble in 2022, and now the banking problems of 2023. I think of that as all one big crisis-- we’re still in the aftermath of 2020.

In that aftermath, with assets inflated to $8.4 trillion, the Federal Reserve is by far the biggest bank in the country. It is also the biggest savings & loan, because inside the Fed is a mortgage portfolio of $2.6 trillion of long-term fixed rate mortgages, funded short with floating rate liabilities. This makes it far and away not only the biggest savings & loan in the country, but in all of history. The Fed is now earning more or less 2% on its mortgages, and more or less 2% on its long-term Treasuries. The duration of its mortgages has become longer than expected with their negative convexity and increasing interest rates. Its Treasuries are also very long, over $1.4 trillion with remaining maturities of more than 10 years. While earning 2%, the Fed is now paying over 5% to carry those investments. If your income is 2% and your cost is 5%, it’s hard to make money that way! From September 2022 to early June 2023, the Fed has had a net loss of $68 billion, and is on its way to an annual loss of about $100 billion, more than twice its capital.

The Fed’s own balance sheet was and is jammed with gigantic interest rate risk. One might not unreasonably ask, how could the Fed criticize banks like the failed Silicon Valley Bank for doing exactly the same thing that the Fed itself was and is doing? A fair question!

Of course, if the failed banks or the technically insolvent Fed had been right in the forecast that short-term interest rates would stay abnormally low, that kind of balance sheet would have been a profitable bet. They could have had 2% income and say, 0.25% interest expense. So let us ask: what was the Fed’s own interest rate forecast as it was accumulating its massive portfolio and interest rate risk?

Consider the Fed’s interest rate forecast done in June 2021 for the end of the year 2022. The median forecast for fed funds target was 0.25%. Of Federal Open Market Committee members submitting estimates, the highest rate was 0.75%. Compared to the 4.25%-4.5% reality, a big miss indeed!

What about the projection for 2023 at that same meeting? What did they think the fed funds target interest rate would be by the end of 2023? The median forecast was 0.75%. The highest submitted estimate was 1.75%. Another big miss, to say the least, with the rate now at 5%-5.25% five months into 2023.

The Fed’s poor forecasts bring to mind that famous American baseball poem, Casey at the Bat. In trying to forecast interest rates, and inflation, and banking problems, just like “Mighty Casey,” the mighty Fed has struck out.

In the meantime, the spring of 2023 provided some extreme drama in U.S. banking, tied significantly to the risk of the American 30-year fixed rate mortgage-- and this cycle is not over. Whatever may the coming in the way of further increases in interest rates, or interest rates continuing at current levels, or an often-predicted recession with lower interest rates but increased loan defaults, all will cause risks to the banking system. In any case, financial markets should remember not to put their trust in the forecasts of the Federal Reserve.

Time To Rein in a Runaway Federal Reserve That Took Congress for Granted

Published in the New York Sun and the Federalist Society.

Juvenal put it best when he asked, who will guard the guardians.

The ancient Roman poet, Juvenal, posed the incisive question that must be applied to all structures of power and authority, “Sed quis custodiet ipsos custodes?” Who will guard the guardians? Let us apply Juvenal’s question to the Federal Reserve.

The Federal Reserve endlessly repeats that it ought to be “independent.” If it is independent, though, who will guard our central bank? The Constitution grants that power — to “coin Money, and regulate the Value thereof, and of foreign coin” — to the Congress.

Every economist with whom I have ever discussed this question immediately replies, “You certainly don’t want a bunch of politicians managing monetary policy.” They all assume that elected politicians will always impose an inflationary bias which the expert central bank will resist.

Yet it was the Fed, without congressional approval, that unilaterally announced in 2012 that it was committing the nation to inflation and perpetual depreciation of its currency at the rate of 2 percent a year. That means average prices quintuple in a lifetime — an odd interpretation of the Fed’s statutory mandate of “stable prices.”

Would Congress have approved a commitment to 2 percent inflation forever? The Fed didn’t seek or wait for an approval from Congress. “The Congress let us put in an inflation target without being part of the process,” Mr. Bernanke, I was reminded by the Sun, boasted to a recent panel.

In internal Fed discussions when Alan Greenspan was chairman, he suggested that the right inflation target was “zero, properly measured” and that the setting of an inflation target should involve the Congress. The Bernanke Federal Reserve adopted neither suggestion.

Moreover, the Fed unilaterally increased its inflationary tilt in 2020 by announcing, again without the approval of Congress, that the 2 percent target meant on average over some unspecified time, so that it might run higher when the Fed desired.

In contrast, other countries — notably the first country with a formal inflation target, New Zealand — set that target of zero to 2 percent as an agreement between the parliamentary government and the central bank.

Why does the Fed need a guardian? Its formidable power combined with the inherent unknowability of the economic future makes it a most dangerous source of systemic risk, and it experiences the constant temptation to be the captive finance company of the Treasury.

A way to improve the substantive oversight of the Congress would be for the Senate Banking Committee and the House Financial Services Committee to each form a new subcommittee devoted solely to engaging the key issues of the Federal Reserve.

The central bank is important enough to the country and the world, and powerful enough for good or bad, to merit this accountability. How much the mandarins of the Fed would hate this idea is a good measure of how important it is.

Such subcommittees would not be impressed by the “pretense of knowledge,” in F.A. Hayek’s particularly perceptive and piercing phrase. Nowhere is this pretense so common as in the Federal Reserve and central banks in general.

These subcommittees would be studying and quizzing the Fed about its recently released first quarter financial statements. They would be probing its knowledge and skill, and examining its booking massive net losses. They would examine how the Fed has itself become technically insolvent.

These are the results of its truly remarkable $5 trillion mismatch of long term, fixed rate assets, including $2.6 trillion of mortgage securities, funded by floating rate liabilities. This has become an expensive mismatch indeed.

In the first quarter alone, the Fed suffered a net loss of $27.7 billion. That annualizes to a net loss for the year of about $110 billion — a number big enough to get anyone’s attention. When the Fed is making money, its profits go to reduce the federal deficit; when it loses money, the government’s deficit is increased.

Did the Fed discuss with the Congress how the interest rate risk it took was going to cost the government $110 billion this year? And how much in the coming years? What could be done? Should the Fed’s dividends to its shareholders be cut? Should its paying the expenses of the unrelated Consumer Financial Protection Bureau be scrapped?

The Federal Reserve has lost billions every month since October 2022, up to an aggregate net loss of $70 billion so far. This far exceeds its total capital of $42 billion, so the Fed’s actual capital is now negative $28 billion and constantly getting more negative. The Fed insists that its negative capital doesn’t matter, but would Congress agree? Might Congress prefer the greatest central bank in the world to have positive capital?

Finally, it is certainly time to reconsider the question of committing the nation to inflation forever at 2 percent, with the engagement and required approval of the Congress. The Money Question — in Latin or plain English — is far too important to be left to unguarded central bank guardians.

June 16 event: The 2023 Bank Runs and Failures: What Do They Mean Going Forward?

Hosted by the Federalist Society.

William M. Isaac - Chairman - Secura/Isaac Group

Keith Noreika - Executive VP & Chairman, Banking Supervision & Regulation Group - Patomak Global Partners

Lawrence J. White - Robert Kavesh Professorship in Economics - Leonard N. Stern School of Business, New York University

MODERATOR

Alex J. Pollock - Senior Fellow - Mises Institute

This year’s sudden collapse of First Republic, Silicon Valley, and Signature banks were the second, third, and fourth largest bank failures in US history, bringing perceived systemic risk and bailouts of wealthy depositors. In addition, the global Credit Suisse bank collapsed and commercial real estate losses threatened. Politicians, regulators, and bankers are debating why the massive regulatory expansion following the last crisis didn’t prevent the renewed failures. Some emphasize repetition of the classic financial blunder of buying long and borrowing short. Others question the 2018 reforms to the Dodd-Frank Act, or cite the monetary actions of the Federal Reserve. Various proposals include more deposit insurance, mark-to-market accounting, higher capital requirements, more stress tests, or bigger regulatory budgets.

Our expert panel discusses the issues and risks going forward, the outlook for new legislation and regulation, and what, if anything, should be done.