Bad Investments Have Left the Fed Nearly Bankrupt
By Christopher J. Petherick
Recent reports that, in the second week of October, U.S. financial institutions borrowed on average $437.5 billion a day from the Federal Reserve have reinvigorated debate over whether the U.S. central bank is overextended—in other words, broke.
The unprecedented amount of loans made by the Fed during the week that ended Oct. 15 was only slightly higher than the week before when Fed loans to cash-strapped banks averaged $420.16 billion per day.
The Federal Reserve is playing a dangerous game of risk, gambling that its roll of the dice will end well— meaning that bankers will be able to pay back these huge loans and all of these cheap dollars will not feed inflation.
Bankers are unique among businessmen, as they log loans—debt—as assets, not as liabilities, on their balance sheets. This is important, because, while the Fed’s balance sheet is still “positive” on paper, it has changed significantly since the financial crisis began.
Before the collapse of the credit markets, the Federal Reserve had approximately $868 billion in assets on its balance sheet, over 90 percent of which was in Treasury bills and bonds. As of today, its balance sheet has exploded to over several trillion in “assets,” with approximately 25 percent of these in T-bills and bonds. The Fed’s assets now mostly comprise loans it has made to other banks, investment firms, insurance giant AIG and foreign banks.
The problem here stems from the fact that the Fed, known as the lender of last resort, has expanded what it normally would accept as collateral for the loans it makes. These include bank equity, other loans including those from troubled banks and the very securities that caused all of these financial troubles in the first place.
Theoretically, the Fed could keep the printing presses running day and night, offering trillions of dollars more to banks that would otherwise collapse without these cash infusions. But with true inflation—as opposed to core inflation, which excludes energy and food prices—at 13 percent to 14 percent, the Fed risks crushing businesses and homeowners under hyperinflation.
The other problem for the Fed is, if all of those banks it continues to loan money to eventually fail, the central bank would be stuck with trillions of dollars in bad loans, which would break it.
Americans should not necessarily look to all of this as bad news. A collapse of the Fed would herald the end of this great experiment in debt-based dollars brought about by the Federal Reserve Act of 1913 and would fuel calls for a new constitutional fiscal paradigm of debt-free dollars issued by the Treasury or backed by precious metals.
Christopher Petherick is a journalist and publisher based in Maryland. For more information, see his website at www.brandywinehouse.us or write directly to BRANDYWINE HOUSE BOOKS AND MEDIA, P.O. Box 638, Cheltenham, MD 20623. Petherick encourages all readers with Internet access to sign up for AFP’s free weekly email newsletter. It’s loaded with house news and special offers available only to newsletter recipients and AFP web site users. See AmericanFreePress.net.
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(Issue # 44, November 3, 2008)