Fed Says “It Doesn’t Matter” How Much Money It Loses Shrinking Its Balance Sheet

(Bloomberg) — The Federal Reserve is piling up unrealized losses on its $4.1 trillion bond portfolio, raising questions about its finances at a politically dicey moment for the independent central bank.

The Fed had losses of $66.5 billion on its securities holdings on Sept. 30, if it marked them to market, according to its latest quarterly financial report. That dwarfed its $39.1 billion in capital, effectively leaving it with a negative net worth on that basis, a sure sign of financial frailty if it were an ordinary company.

The Fed, of course, is not a normal bank and does not mark its holdings to market. As a result, officials play down the significance of the theoretical losses and say they won’t affect the ability of what they call “a unique non-profit entity’’ to carry out monetary policy or remit profits to the Treasury Department. Case in point: the Fed handed over $51.6 billion to the Treasury in the first nine months of the year.

The risk though is that any perceived deterioration in the Fed’s finances could dent its standing with Congress and the public when it is already under attack from President Donald Trump as being a bigger problem than trade foe China.

“A central bank with a negative net worth matters not in theory,’’ former Fed Governor Kevin Warsh said in an email. “But in practice, it runs the risk of chipping away at Fed credibility, its most powerful asset.’’

The unrealized losses also provide fuel to critics of the Fed’s huge bond buying programs — commonly known as quantitative easing — and the monetary operating framework underpinning them, just as central bankers begin discussing the future of its balance sheet. The ostensible red ink also could make it politically more difficult for the Fed to resume QE if the economy turns down.

“We’re seeing the downside risk of unconventional monetary policy,’’ said Andy Barr, the outgoing chairman of the monetary policy and trade subcommittee of the House Financial Services panel. “The burden should be on them to tell us why this does not compromise their credibility and why the public and Congress should not be concerned about their solvency.’’

Behind the mounting book losses are the Fed interest rate increases that Trump has attacked. They’ve put downward pressure on the prices of the Treasury and mortgage-backed securities that the Fed purchased to aid the economy during and after the financial crisis. The numbers jump around. For example, those losses totaled a less eye-catching $19.6 billion on June 30. They could narrow again this quarter if the recent Treasury market rally holds.

The Fed is currently reducing its bond holdings by a maximum of $50 billion per month — not by selling them, which could force it to recognize an actual loss — but by opting not to reinvest some of the proceeds of securities as they mature.

Fed Chairman Jerome Powell and his colleagues began in-depth discussions about how far to pare back its portfolio of Treasury and mortgage-backed securities at their meeting last month, the minutes of that gathering show.