The Fed Is in the Red. Here’s Why
Narrator: In some ways, the Federal Reserve is like a company. It has a balance sheet with assets that bring in money on one side and liabilities that cost money on the other. But what the Fed keeps on its balance sheet has ramifications for the economy.
Nick Timiraos: The balance sheet is the tool that they use to control and manage interest rates.
Narrator:And for the last 15 or so years, the Federal Reserve has actually made money off of this balance sheet... until today. Thanks to, well, the Fed’s own policies.
Nick Timiraos: They’re losing money because they’re raising interest rates a lot.
Narrator: Here’s how the Fed makes money and why they’re not now.
This is what their balance sheet looks like. On the asset side, they have US treasury securities like bonds. They’re considered really stable, low-risk investments. And the Fed buys them, sometimes, a lot of them, to help stabilize the economy.
Nick Timiraos: The point of it is to bring down longer-term interest rates, so if more people are purchasing these securities, in this case, the Fed, that’s gonna drive down the interest rate; there’s more demand for the bond.
Narrator: And the Fed purchases mortgage-backed securities too, which are what they sound like. When they invest in them, they’re basically investing in people’s mortgages.
Nick Timiraos: If you have a 2.5% mortgage rate, that was in part because the Fed was buying mortgage-backed securities during the pandemic.
Narrator: So that’s the asset side, which totals nearly $9 trillion. On the liability side, the Federal Reserve has literally all of the currency in circulation. It’s why all money has Federal Reserve Note written on it. It’s a liability of the Fed, the US Central Bank. The Fed is also a bank for other banks, and their main liability is reserves of money that other banks keep at the Fed. It’s another way they can influence the economy.
Nick Timiraos: There’s some concern that if you had all of this money out there, you could have even more inflation; you could have economic effects that you don’t intend. So one of the ways to prevent that money from spurring even more demand is to have banks hold it at the Fed, and the Fed controls interest rates by setting the rate of interest on those reserves.
Narrator: When the Fed raises interest rates on these reserves, it affects other markets, from bank loans to mortgages. But really, it means the Federal Reserve has to pay more in interest to those banks. For years, that amount was really low, usually below 1%. Yet, the Fed’s assets, on average, paid 2.3% in interest. So the Fed’s assets were bringing in more interest than its liabilities were costing. The Fed was actually turning a profit, and it would send that profit to the US Treasury. In the last 11 years, this profit would range from about 4 to $12 billion a month.
Nick Timiraos: The money that the Fed sends to the Treasury means the Treasury doesn’t have to raise as much money in the private market. It means the borrowing needs of the US government are smaller; it means deficits are lower than they would otherwise be.
Narrator: But now that the Federal Reserve is raising interest rates, that profit is now a loss.
Nick Timiraos: They are raising interest rates so much that they’re gonna pay more out than they take in.
Narrator: This idea of the Fed even having a profit or loss is a relatively new one. Before 2008, the Fed’s balance sheet looked like this, about $1 trillion in assets and liabilities, mainly treasury securities to cover the currency in circulation. But then, the 2008 financial crisis hit. They dropped interest rates to zero, but wanted to do even more, so they bought treasury and mortgage-backed securities to push interest rates down even further. That began a decade of growth of the Fed’s balance sheet as interest rates stayed low and the Central Bank utilized these assets and liabilities to influence the economy, although they tried to shrink the balance sheet at times.
Nick Timiraos: The plan was never to permanently expand the balance sheet. Then COVID comes, and there was a financial panic in March, 2020. And they bought just an enormous, staggering amount of treasury securities and mortgage-backed securities.
Narrator: So with a large balance sheet comes large profits, but now also large losses.
Nick Timiraos: So, when the Fed loses money, what happens? They create basically an IOU where they will pay back later the money that they’re losing now, they call this a deferred asset.
Narrator: Basically, they’ll pay themselves back later. The Treasury will have less money, which means they’ll have to take on more debt to add to the deficit. But for the Federal Reserve, experts say it shouldn’t change their day-to-day operations, and they’re not too worried about it.
Nick Timiraos: The Fed’s pretty clear, their goals are to achieve low and stable inflation and strong employment. It doesn’t say anything anywhere that they’re supposed to make a lot of money for the US government. And so that’s how they’re treating this right now.
Narrator: Now that the Fed has accumulated such a large balance sheet to manage the economy, it must manage not just its gains but also its losses.