Steve Baker MP: The FED is Very Nearly Bust and it is Probably Not Alone amongst Central Banks

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According to Steve Baker MP, a review of the US Federal Reserve’s own document reveals that the Federal Reserve, the US central bank is very nearly bust. Here is an extract from his article from 1st September 2011:

The size of the Fed’s balance sheet is now about $2,843 billion, up from about $800 billion three years ago. The huge increase in the Fed’s balance sheet stems from bailouts, quantitative easing, and other central bank “liquidity” operations. There’s been a massive change in the structure of the Fed’s assets too.

 

 

The Fed’s capital base is $71 billion. That represents about 2.5% of its assets, or a leverage ratio of 40 times its capital. This ratio would have been considered unthinkable prior to the crisis: it is about four times greater than that permitted by the new Basel proposed rules for commercial banks and simply demonstrates that the bailout format and quantitative easing do not make these problems go away. If the patient has been incorrectly diagnosed, taking the wrong medicine will not cure him.

 

This capital to asset ratio means that a loss on its assets of 2.5% would be enough to make the Fed, by any normal standard, insolvent – unable to pay its debts. So how plausible might such a loss be?

 

… The Fed and the Bank of England both fear the revelation to the public of the truth: that the bank bailout and QE has not worked, that the commercial banks refuse to lend to each other out of solvency concerns and that this systemic toxicity has now infected the central banks.

 

Were the two central banks to raise rates by a modest degree, then the fig leaf of solvency would fall to the floor and reveal this naked truth. That is why specious arguments are ventilated about the risk of price deflation when both countries risk accelerating inflation. These arguments are used to justify near zero interest rates, imperilling both countries’ hopes of lasting economic recovery.

 

 

You can read the whole article here.

 

 

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  • Zoidberg

    Great article Mira! The core solvency issues keep being mistaken for liquidity problems, same as 2007.

  • RJ

    “insolvent – unable to pay its debts”

    This Fed will never not be able to pay its debts.

    http://rodgermmitchell.wordpress.com/2010/08/13/monetarily-sovereign-the-key-to-understanding-economics/

    Perhaps no words more accurately and succinctly illustrate the confusion about economics than “Monetary Sovereignty.” A Monetarily Sovereign government has the exclusively unlimited power to create its sovereign currency. Monetary Sovereignty is the foundation of economics. The United States is Monetarily Sovereign. It has the exclusively unlimited power to create the dollar. China, Canada, Australia and Japan are Monetarily Sovereign. They have the exclusively unlimited power to create their sovereign currencies.

    Illinois, Cook County and Chicago are not Monetarily Sovereign. The dollar is not their sovereign currency, and they do not have the unlimited power to create dollars. France, Germany and Italy are not Monetarily Sovereign. They do not have the exclusively unlimited power to create their currency, the euro. You, your business and I also are not Monetarily Sovereign. Even Bill Gates and Warren Buffet do not have the unlimited power to create dollars. They are not Monetarily Sovereign.

    Because a Monetarily Sovereign nation has the unlimited power to create its sovereign currency, it never needs to borrow and it never can be forced into bankruptcy. It can pay any bill of any size at any time. In fact, the federal government creates money by paying its bills. The U.S. has created many trillions of dollars, simply by pressing computer keys, and will continue to do so.

  • RJ

    And here’s a comment to this article explaining why this article by Steve Baker is nonsense

    Matthew Evans said…

    This article is based on a misunderstanding of the accounting rules which govern the Fed. Unlike private institutions, the Fed does not mark to market the price of the government bonds it owns. Thus when interest rates go down it does not say it has made a capital gain and when interest rates go up it does not record a loss.

    The reason for the difference is that the Fed can never be forced to sell these assets at a loss because of the need for liquidity. If the Fed needs money, it just has to print some. When people say that a country with its own currency cannot go bust, they usually in fact mean that the central bank of that country cannot go bust, because governments can fail if the central bank refuses them funding.
    So with a 5 year bond, all the Fed has to do is wait for 5 years and it will get back 100 cents on the dollar.

    The Fed could make a real loss in some circumstances. If the economy recovers and the Fed decides to tighten policy by selling bonds at a time when rates have already risen then it might indeed make a loss. But the amount is far less than this piece assumes and it could be avoided altogether by using other means of monetary tightening and just allowing the bond portfolio to mature to extinction.

  • Nic the NZer

    I don’t agree with some of the content of this article. I think it’s a bit miss-leading. The solvency of the US fed/Bank of England are not particularly relevant. Their solvency is not related to a commercial banks solvency.

    Commercial banks are happy enough to lend to each other as well, though this is not going to be necessary if they have large capital reserves.

    The reason that the bailouts have failed is simple. Giving money to banks does not create any new borrowers. Until banks can find good quality borrowers then no lending happens and credit money does not expand (in a fractional reserve system). This is why the positive money proposals will lead to a recovery, because new growth (starting from the government accounts) will be possible as long as additional debt does not need to be taken on.

    In Australia every wage earner got a $1000 AUS tax break for stimulus, not a huge bank bailout. This has worked better than the US bank bailouts, but increases Australian government debt. I think this highlights what I have said is correct, though there are other differences.

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