Fed Losses May Cause Crisis, Bernanke’s Colleague WarnsFebruary 25th, 2013
In an attempt to delay the inevitable, the Federal Reserve has been experimenting with quantitative easing, a policy through which interest rates are pushed unnaturally low by monthly purchases of $85 billion worth of mortgage-backed securities and Treasuries. Meanwhile, western central banks have apparently been selling their gold and silver holdings to eastern central banks, possibly while pretending to still have them. Could this be an effort to try to artificially suppress gold and silver prices?
Newsmax is reporting that a group of Fed-associated economists recently drafted a paper issuing dire warnings about the contents of the central bank’s balance sheet. Frederic Mishkin, a former Federal Reserve governor who worked side-by-side with Bernanke on academic research, is one of the drafters of the report. In it, economists warn that the Federal Reserve may be put in a position to lose money if interest rates are raised, thus encouraging the bank to continue its quantitative easing program past an inflationary point of no return.
Those Toxic Assets Had to Go Somewhere
Artificially re-inflating bubbles is a game of hot potato. Rational economic actors tend to try to reduce their exposure to losses. When the Fed offers to buy up worthless toxic assets, banks will jump at the chance to unload risk-exposed financial products. In the case of mortgages, for example, this works to hold the price up temporarily. However, the stark reality exists that such demand is artificial. At some point, the difference between central bank stimulated purchases and real consumer demand must be written off, either as losses, or through the monetization of debt, leading to inflation. The sooner this occurs, the less disastrous it will be.
However, this new report, authored by Columbia University economist Frederic Mishkin, David Greenlaw from Morgan Stanley, UC San Diego professor James Hamilton, and Deutsche Bank Securities’ chief economist Peter Hooper, warns that the central bank’s balance sheet may not be able to sustain a timely reversal of its quantitative easing policy, leading to a serious crash. The paper cautioned, “This unfavorable fiscal arithmetic might tend to push the Fed toward delaying its exit from the extraordinary easing measures it has taken in recent years; it could even affect decisions this year about how much further to expand the Fed’s holdings of longer-term government securities. The Fed could cut its effective drain on the Treasury significantly by putting off asset sales and delaying policy rate increases. But such a response would presumably feed rising inflation expectations.”
Can Private Banks Lose Money on Purpose for Years?
The Federal Reserve is a private institution that earns profits. It provides the Treasury with a certain percentage of its earnings each year. This begs an important question: what happens if the Federal Reserve loses money? Will Fed officials be able to promote policies that could cause the bank to report losses for years on end?
Will Bernanke thus keep quantitative easing programs in place past the point of no return to prevent Fed losses, causing an inflationary crisis? Apparently, if Obama and the Congress don’t reduce spending, the Fed will be stuck in a position where any effort to end the fiscal stimulus also puts its own balance sheet at risk. This conflict of interests may cause the Federal Reserve to lose its grip on the world economy, held now only by metaphorical fingertips.