Federal Reserve Chairman Ben S. Bernanke’s efforts to rescue the economy could result in more than a half trillion dollars of paper losses on the central bank’s books if interest rates rise abruptly from recent levels.
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. 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.
“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.
“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.”
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.
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.