The Fed circumvented the debt ceiling to borrow billions for failed banks
As a consequence of its COVID crisis asset purchase program and the subsequent increases in interest rates needed to fight inflation, the Fed is now losing billions of dollars a week.
The Fed’s most recent H.4.1 statement shows that the Fed has borrowed $41 billion to pay its cash losses, but these borrowings do not count as U.S. Treasury debt and are not counted against the congressional Treasury debt ceiling limit.
In the past week, the Fed’s financial statement shows it borrowed an additional $143 billion to fund the FDIC’s bailout of Silicon Valley Bank (SVB) and Signature Bank, even though the FDIC is supposed to fund bank bailouts using the deposit insurance fund and, if need be, by borrowing from the U.S. Treasury. Instead, the Fed borrowed these funds and lent them to the FDIC to keep these bank failures from reducing the Treasury’s cash balances. You may recall that the Treasury is already precluded from any additional borrowing under the current congressional debt limit.
The Fed is now losing billions of dollars each month. The losses are a consequence of the Fed’s huge investment portfolio that yields around 2 percent but costs about 4.6 percent to finance. Measured using generally accepted accounting principles, the Fed is now approximately bankrupt. As operating losses mount in the months and years to come, its cumulative operating losses and the Fed’s GAAP equity capital deficit will grow.
The Fed pays for its cash operating losses in two ways. It can print paper Federal Reserve Notes which pay no interest, or it can borrow reserve balances from banks and other financial institutions through its reverse repurchase program. When it borrows, it pays the lenders the interest rate on reserve balances (4.65 percent) or the rate on reverse repurchase agreements (4.55 percent).
The Feds’ ability to fund these losses by printing paper currency is limited by the public’s demand for Federal Reserve Notes. As a practical matter, the Fed borrows most of these funds. Between March 1 — the week before the SVB and Signature Bank runs — and March 15, the last Wednesday data point available for reserve balances, the Fed’s total reserve and reverse repurchase borrowing increased by $175 billion.
The FDIC is supposed to fund the cash expenses generated by failed bank receiverships by using balances in the deposit insurance fund, drawing on the FDIC’s line of credit with the U.S. Treasury or utilizing the Treasury’s Federal Financing Bank.
As of year-end 2022, The deposit insurance fund had assets of a little over $128 billion invested in government securities. The Fed’s $143 billion loan to the FDIC indicates that the actual cash needs of the SVB and Signature Bank failures would have more than exhausted the FDIC’s deposit insurance fund. Beginning a potential banking crisis with a fully depleted insurance fund would not have instilled confidence in the administration’s claim that the banking system is “sound.”
The FDIC is authorized to borrow up to $100 billion from the U.S. Treasury. It is required to repay the loan with interest using the proceeds of asset sales from failed bank receiverships. While the FDIC could have tapped this line of credit to help fund the SVB and Signature Bank failures, the Treasury’s general account balance with the Fed is down to about $278 billion, and the Treasury needs these balances to pay the Federal government’s expenses since it is precluded from issuing any new debt by the congressional debt ceiling.
The FDIC can also borrow from the Treasury using the Federal Financing Bank (FFB). The FFB can purchase any obligation issued, sold, or guaranteed by a federal agency that does not have direct authority to borrow. The FDIC would pledge assets from failed bank receivership to the FFB which would in turn loan the FDIC funds to manage its failed bank receiverships. The FFB’s lending activities are included in the budget of the United States and any debt the Treasury would issue to fund FFB lending would count against the federal budget deficit and the congressional debt ceiling.
So faced with cash demands to finance the SVB and Signature Bank failures, dwindling Treasury cash balances, and a congressional debt limit that precludes additional Treasury borrowings, the administration decided to circumvent the FDIC’s legally authorized funding sources and use Federal Reserve emergency lending powers to fund the FDIC bailout.
The Fed is now borrowing to fund the FDIC loan as well as the Fed’s own operating losses to the tune of $184 billion, and yet these costs do not show up in the Federal budget deficit nor do the Fed’s borrowing count against the congressional Federal debt ceiling even though these borrowings clearly are U.S. government debt.
If Congress does not have a heart-to-heart discussion about this issue with the secretary of the Treasury and Fed Chair Powell, they have all but abdicated their most important power — the power of the purse. Let’s hope they have that discussion soon.
Paul H. Kupiec is a senior fellow at the American Enterprise Institute.
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