That sum is the difference between the value of securities in the Fed’s portfolio on Dec. 31 and what they may fetch in three years, according to data compiled by MSCI Inc. (MSCI) of New York for Bloomberg News. MSCI applied scenarios devised by the Fed itself for stress-testing the nation’s 19 largest banks.
MSCI sees the market value of Fed holdings shrinking by $547 billion over three years under an adverse scenario that includes an economic contraction and rising inflation. MSCI puts the Fed’s mark-to-market loss at less than half that, or $216 billion, if the economy performs in line with consensus forecasts of gradually rising growth, inflation and interest rates.
The potential losses are unprecedented in the Fed’s 100- year history. Bernanke began describing in detail the risk of lower payments to taxpayers for the first time today in his monetary policy testimony before the Senate Banking Committee saying that “remittances to the Treasury could be quite low for a time” if interest rates “were to rise quickly.” Bernanke didn’t describe the overall interest-rate risk to the portfolio or potential mark-to-market losses. He said the Fed is “confident” it has tools to tighten monetary policy.
Where’s Money?
“You can easily imagine a naive congressional response, which is ‘Where did the money go?’ ” said Sarah Binder, a senior fellow at the Brookings Institution who researches the relationship between the Fed and Congress. “Even if there’s a perfectly logical explanation and the normalization of the balance sheet is a good thing in the long term, the headlines will probably generate congressional scrutiny,” said Binder. “That’s never a good thing from the Fed’s perspective.”
The risk of mark-to-market losses under some scenarios is the price of Bernanke’s battle to overcome the deepest recession since the Great Depression as the Fed embarked on three rounds of so-called quantitative easing. The benefit is more jobs and higher growth, Fed officials say.
“To the extent that monetary policy promotes growth and job creation, the resulting reduction in the federal deficit would dwarf any variation in the Fed’s remittances to the Treasury,” Bernanke said in today’s testimony.
Corker Inquiry
Senator Bob Corker, a Republican from Tennessee, sent Bernanke a follow-up letter this afternoon asking for the central bank to provide further details about how losses would affect the Fed’s operations.
“Do we have a serious policy problem brewing here, or is this simply an optics problem about which we should not be concerned?” Corker asked.
The Fed doesn’t mark its portfolio to market, and its losses may be only a fraction of MSCI’s totals because the central bank could hold the bulk of its assets to maturity. The central bank cannot go bankrupt and can continue to operate with losses on its books.
“There’s a cost to very significant stimulus -- and that’s OK if the stimulus is a good investment -- and I think a lot of what the Fed has done is a very, very good decision,” said Representative John Delaney, a Maryland Democrat and member of the House Financial Services Committee, where Bernanke testifies tomorrow. “Their actions right now are having diminishing returns and increasing the severity of this future loss that will be incurred as rates go up.”
Bernanke’s Legacy
Bernanke’s legacy will be judged in part by how the Fed exits from its emergency policies, a prospect that is already troubling the Federal Open Market Committee and some members of Congress. Bernanke, 59, ends his second four-year term as Fed chairman on Jan. 31, and he hasn’t said whether he wants to stay in the job after that.
Four economists, including Frederic Mishkin, a former Fed governor and co-author with Bernanke, argued in a paper presented in New York on Feb. 22 that the central bank’s grip on policy may weaken if losses coincide with high U.S. budget deficits and an inability of Congress and the White House to put fiscal policy on a sustainable path.
“This mix could induce a bias toward slower exit or easier policy, and be seen as the first step toward fiscal dominance,” the economists said in the paper, presented at the U.S Monetary Policy Forum, referring to fiscal influence on monetary policy. “It could thereby be the cause of longer-term inflation expectations and raise the risk of inflation overall.”
Fed’s Flexibility
In response, Fed Governor Jerome Powell said at the conference that policy makers “have the flexibility to normalize the balance sheet more slowly” to avoid taking losses and causing market disruptions. He said there’s “no reason” to expect the Fed won’t act to prevent inflation.
Boston Fed President Eric Rosengren said that “this discussion does not do justice to the policy trade-offs” of the central bank’s quantitative easing, because the stimulus boosts growth and also improves the fiscal outlook by lowering borrowing costs.
Now, it’s Bernanke’s turn to convince lawmakers.
“When they start losing money -- that is going to be a big issue” on Capitol Hill, said Hester Peirce, a former senior counsel to Republican staff on the Senate Banking Committee who is now a senior research fellow at the Mercatus Center at George Mason University in Arlington, Virginia. “There will be more pressure to watch the Fed closely.”
Bernanke is implementing the most aggressive monetary policy in the central bank’s history to support growth and employment. After the Fed’s benchmark rate was cut to a range of zero to 0.25 percent in December 2008, the chairman began buying more bonds to lower longer-term financing costs for home buyers, companies and consumers.
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