Is there really no effect to the Fed balance sheet effectively having negative equity? I realize they have their own central banker terminology but it’s effectively negative shareholder equity.
So, at some point in the near future a new item will appear on the asset side of the BS called 'deferred asset' and on the liability side of the BS an equivalent amount of reserves will be credited to the banking system. The Liability for Earnings Remittances to the U.S. Treasury will then move to zero (rather than negative now), allowing the capital to move back to about $50bln.
I believe this is perfectly fine, but it does pose presentational problems. The additional reserves also pay interest so will add to the problem somewhat. The modelling of the Fed has the 'deferred asset' falling to zero between 2027-2030, mostly (as far as I can tell) because the Fed intends to hold a large stock of Treasuries going forward and interest income will gradually increase from this stock. However, that does assume a flat to normal yield curve so if the current inversion continues the return to normal will be delayed.
Hi Glenn, good question. My answer is 'yes', but that this is the best approach for the Fed. The sooner the Fed establish the scale of the loss, the sooner the issue simply becomes a balance sheet curiosity, slowly diminishing.
Is there really no effect to the Fed balance sheet effectively having negative equity? I realize they have their own central banker terminology but it’s effectively negative shareholder equity.
Well, I guess we'll see. I expect a 'willing suspension of disbelief' to rule.
As a starting point, shareholder equity remains positive at present, but capital is eroding fast as this FRED chart shows: https://fred.stlouisfed.org/graph/?g=109CN
The Fed anticipated this (albeit with a central Fed Funds target much lower than currently) and explained their plans in 2 papers ( here https://www.federalreserve.gov/econres/notes/feds-notes/an-analysis-of-the-interest-rate-risk-of-the-federal-reserves-balance-sheet-part-1-20220715.html and here https://www.federalreserve.gov/econres/notes/feds-notes/an-analysis-of-the-interest-rate-risk-of-the-federal-reserves-balance-sheet-part-2-20220715.html)
So, at some point in the near future a new item will appear on the asset side of the BS called 'deferred asset' and on the liability side of the BS an equivalent amount of reserves will be credited to the banking system. The Liability for Earnings Remittances to the U.S. Treasury will then move to zero (rather than negative now), allowing the capital to move back to about $50bln.
I believe this is perfectly fine, but it does pose presentational problems. The additional reserves also pay interest so will add to the problem somewhat. The modelling of the Fed has the 'deferred asset' falling to zero between 2027-2030, mostly (as far as I can tell) because the Fed intends to hold a large stock of Treasuries going forward and interest income will gradually increase from this stock. However, that does assume a flat to normal yield curve so if the current inversion continues the return to normal will be delayed.
If the Fed papers are too long, there is also a good (short) paper by William English and Donald Kohn https://www.brookings.edu/blog/up-front/2022/06/01/what-if-the-federal-reserve-books-losses-because-of-its-quantitative-easing/
Doesn’t squashing inflation via higher ST rates bring the bill forward? EG, the Fed winds up paying more on reavers and repo, sooner.
Hi Glenn, good question. My answer is 'yes', but that this is the best approach for the Fed. The sooner the Fed establish the scale of the loss, the sooner the issue simply becomes a balance sheet curiosity, slowly diminishing.