The US Federal Reserve has unrealised losses of $53.2bn on its securities portfolio, laying bare the potential long-run price of quantitative easing

March 14, 2014 5:36 pm

US Federal Reserve’s unrealised losses rise to $53.2bn

By Robin Harding in Washington

The US Federal Reserve has unrealised losses of $53.2bn on its securities portfolio, laying bare the potential long-run price of quantitative easing.

Even though the losses may never be realised, the disclosure in the Fed’s 2013 annual report will provide ammunition for critics, who argue the central bank is wrong to risk losses when it eventually raises interest rates.

The Fed’s portfolio of Treasury securities is held on its books at $18bn more than their market value while its mortgage-backed securities are marked at $38bn above the price at which they could currently be sold.

That shows how the $4tn asset portfolio the Fed has built up exposes the taxpayer to swings in interest rates. Ten-year Treasury yields rose from about 1.6 per cent at the end of 2012 to 2.6 per cent at the end of 2013, moving the Fed’s balance sheet from an unrealised profit to an unrealised loss.

The Fed has said it does not intend to sell MBS and will hold them to maturity. In that case it will never realise the capital loss.

The unrealised capital loss was disclosed at the same time as the Fed reported an annual profit of $79.1bn, down 13 per cent compared with 2012, because gains from selling short-term securities as part of a programme knows as “Operation Twist” were not repeated.

The Fed remits all of its profits to the Treasury. It makes vast sums at the moment because it pays banks just 0.25 per cent on their reserves but buys long-term Treasury securities yielding 2 or 3 per cent.

But that could turn into losses in the future, because higher interest rates will raise what the Fed pays on bank reserves while the return on its longer-term assets remains fixed.

Footnotes to the Fed’s annual report reveal that it now owns $660bn of MBS with a coupon of 3 per cent or less. The market value of such securities will fall substantially when interest rates are higher.

The potential losses do not constrain the Fed’s policy, because its income is large enough to absorb them, but highlight longstanding concerns that they could pose a public relations problem for the central bank.

Republicans have fiercely criticised the Fed’s QE policy and any losses – even if outweighed by earlier profits – could give their arguments new force.

Net interest income rose from $78bn in 2012 to $85bn in 2013 as the Fed carried out more than a trillion dollars of asset purchases that took its total balance sheet above $4tn in size.

But $13.2bn in profits from selling short-term Treasuries were not repeated. The Fed made those gains in 2012 when it was selling its short-term holdings in order to buy long-term securities – known as Operation Twist – as part of an effort to drive long-term interest rates down further.

The Fed’s annual financial statements also revealed that total assets in the Maiden Lane vehicles used to bail out Bear Stearns and AIG have fallen to just $1.9bn, from $2.8bn the year before, as the winding down of their portfolios continues.