We’ve pointed out more times than we can count that the Federal Reserve currently has around $9 trillion dollars of securities on its balance sheet.  This includes trillions of dollars of mortgage securities its not allowed to own.  The main reason that inflation has been so high this year has been the Fed’s increase of the money supply and a huge part of that is the increase in the balance sheet.  The Fed is starting to go from quantitative easing to tightening in order to reverse that.

Here’s the issue:  Right now, the Fed is letting maturing securities roll off the balance sheet, and that’s reducing the assets held slowly.  The Fed’s huge increase in the money supply led to inflation and asset bubbles.  If they ever decide they need to increase the pace of tightening, that would mean selling some of the securities currently held.  As the Fed has increased interest rates this year much faster than the market had expected, the value of bonds and mortgage backed securities declines.  So, if and when the Fed sells these securities which were issued and bought when rates were lower (and were therefore much more expensive), it’s going to take losses.

Our question is who is going to cover those losses?  The Fed has never had a balance sheet this big and while interest rates are still low, the recent changes have been rapid.  The Federal Reserve is a quasi-governmental agency.  While it answers to the government, needs to have Governors approved by Congress, and can create dollars, technically, it’s owned by the member banks.  Are they going to be taking those losses, or will we be looking at another taxpayer-funded bailout here?  We don’t know the answer yet.  Open to your thoughts.