If the Fed were a commercial bank, it might be declared insolvent
Recently, I have written quite a few posts highlighting the U.S. Federal Reserve’s ballooning balance sheet. It has increased purchases of assets at an unprecedented clip. In fact, that balance sheet had $900 billion in assets just this past year. By year’s end, we should expect it to have risen more than three-fold to $3 trillion. This is a wild experiment without parallel in modern history.
But, there is a cost to all of this. One cost, hidden behind much of the chatter about bailouts, loans to lending institutions, and debt guarantees, is the damage to the Fed’s balance sheet. If the Federal Reserve were a commercial bank, any regulator would declare the institution insolvent due to inadequate capital and shut it down. The Federal Reserve now has leverage of over fifty times capital and this figure is expected to rise. The Fed needs $48 billion in capital just to get back to the capital ratios it had last year.
How this experiment ends is anybody’s guess. However, below is an article in this week’s Barron’s pointing out how extreme things at the Federal Reserve have become. Notice the sharp reduction in U.S. treasuries and the huge increase in securities lent to dealers and overall assets. Very worrying.