The $4.3 Trillion Nothingburger

May 27, 2016
Yahoo Finance: The Federal Reserve's $4.3 trillion ticking time bomb

The Federal Reserve has a big problem if it wants to raise rates again.

The first time? No problem. The next time? Big problem. Yeah, right. As a long-term holder of long-term treasury bonds, I welcomed the move. I did not become a mythical bond vigilante. I did not panic. Nothingburger.

According to several leading economists, it’s also possible that the Fed will become technically insolvent (though it always has the power to print its way out of such a disastrous state).

In a world with thousand upon thousands of leading economists I do not trust to predict rain when it is raining, several completely anonymous ones say the Fed could become insolvent. Maybe. Good to know. I'll plan accordingly by embracing the nothingburger.

Currently, the Fed pays 0.50% annually to banks to keep that money out of the economy. It might not seem like much, but the comparable rate paid by the U.S. Treasury for T-bills is 0.28%. In other words, the Fed pays banks nearly twice as much as the Treasury does.

This is awesome news for me! Capital One, a bank, is paying me 0.75% on my online savings account. What idiots! That's nearly three times as much as the Treasury does! The savvy Fed is only offering 0.50%. Yellen must be a shrewd negotiator.

This is a huge expenses for the Fed.

This is a huge expenses? Seriously?

But it gets worse.

Of course it does.

The Fed is taking capital losses on its $4.3 trillion bond portfolio, and those losses will eventually accelerate. When the bonds that the Fed holds mature, it realizes losses because it paid above-market prices for most of them to begin with.

I've been a buyer too. I'm holding to maturity. Even if I sold today, which I'm not, none of my bonds would have a capital loss. Not one.

It's almost like long-term rates have not risen from when I bought them.

It's almost like my long-term bonds become shorter-term bonds over time.

Is almost like it's nearly impossible to take much of a capital loss on a long-term bond that has only one day left until maturity.

It's almost like we no longer even call it a long-term bond if it's only got one day left until maturity.

It's almost like we call it a short-term bond instead.

Seriously. The Fed pays $1000 to buy a bond. It matures and pays the Fed back its $1000. The Fed also earned interest while it owned the bond. Where is the capital loss? Simple answer: This story is complete and utter nothingburger. And when I use nothingburger in this context, I really mean that since my time is valuable to me, and I read it, then I have suffered "a huge expenses." Never get this time back. It's gone, lol. Sigh.

I write an Illusion of Prosperity blog and am no particular fan of the Fed, but sheesh, the Fed's balance sheet ranks only slightly higher than being inconvenienced by an extra traffic light on my list of long-term worries.

Nothingburger.