Federal Reserve’s Current Spending Spree

The Federal Reserve has been on a spending spree as of late. What are they buying you might wonder? U.S. Treasury bonds, and there is no sign of them letting up. They currently are spending $85 billion dollars a month in low interest rate Treasury bonds and mortgage backed securities. These bonds now make up about 94% of the Feds portfolio.

In an effort to stimulate the economy and curtail the inflation that they created, the Fed has bought close to $4 trillion dollars’ worth of US treasury bonds since 2008. This actually puts the Fed in a potentially precarious situation where they could face bankruptcy if interest rates were to sharply rise.

No need to worry, stresses Fed Chairman Ben Bernanke, any losses incurred by the Fed would be offset by the more than $300 billion dollars in interest they have earned as a result of the increased holdings. Nonetheless, if the Fed were to sell their bonds at a loss because interest rates rose, it would be up to the U.S. taxpayer to shoulder the loss. Think it couldn’t happen? The Carter administration was certainly caught off guard.

The Fed buys the bonds from other private banks – usually Goldman Sacs. In exchange the bank deposits their excess reserves with the Fed and receives 0.25% interest; the Fed in turn charges 0.75% as their discount rate to other banks. Banks do rather well.

Of course Goldman Sacs sells the bonds to the Fed without charging a commission. They are well known for their compassionate altruism. Just kidding! Of course they charge. The Federal Reserve Act specifies that the Federal Reserve may buy and sell Treasury securities only in the "open market." The Federal Reserve conducts its purchases through "Primary Dealers", such as Goldman Sacs – these by the way, are older securities. The new ones such as the Fed has been gobbling up lately are sold at auction.

This supposedly supports the central bank’s independence in conducting monetary policy but still doesn't seem right. But then the fact that we have a central bank at all instead of the U.S. Treasury printing the money, doesn't seem quite right either now does it?

Wouldn’t it be nice if our Reserve were to actually produce something of value instead of simply engaging in risky arbitrage? Risky for us taxpayers that is, the Fed would simply be bailed out.