Could the Fed become insolvent? It already would be if it wasn't able to print money

It could never go insolvent in the traditional sense, because it can just print more money.  However, since it has become the largest hedge fund in the world, by buying risky assets, mortgages, car companies, etc, it is very exposed to losses, which would either require printing of more money or a cash infusion from the Treasury.   

Possibilities we have been raising here for some time.  A bankruptcy could come in the form of severe deterioration of the assets they have on their book.  Via Reuters:

Last November, as the economic recovery appeared to falter, the Fed said it would buy a new round of $600 billion in Treasury securities through June of this year. That's on top of the $1.7 trillion in Treasuries and mortgage-backed securities it had purchased in response to the financial crisis.

Still, the pitfalls of the Fed's approach are almost as numerous as the lending facilities it undertook to stem the crisis. Perhaps most daunting, the Fed's purchases of Treasury debt and mortgage-backed securities have effectively turned it into a mammoth investor -- a thoroughly undiversified one.

"The biggest risk is losses on its portfolio on long-term debt if inflation rises," said Alan Meltzer, a Fed historian and economics professor at Carnegie Mellon University in Pittsburgh.

That threat is already apparent in the Fed's latest round of bond buying, or so-called quantitative easing. According to calculations by Reuters Insider credit analyst Ed Rombach two weeks ago, the average duration of the Fed's new portfolio of bonds is just under 5 years, and every 1-basis-point rise in 5-year to 6-year Treasury yields results in a loss of about $65 million.

The Fed is sitting on paper losses of about $2.3 billion on the purchases of U.S. Treasuries it made from November 12 until late last week, according to an analysis by Reuters Insider.

The Fed is also vulnerable to losses through its so-called Maiden Lane portfolios, a collection of investments it acquired when it brokered J.P. Morgan Chase's takeover of a floundering Bear Stearns and bailed out failed insurer AIG.

The portfolio will likely generate losses, according to many analysts. Still, the total Maiden Lane portfolio amounts to just $66 billion, a small slice of the Fed's growing pie of securities.

For most Fed officials, a concern over credit losses would be a luxury compared with the risk they see as predominant: that the economy will not grow quickly enough to return more than 14 million unemployed Americans to work, and inflation so low that it leaves the country exposed to possible deflationary shocks.

"The risks are worthwhile given that the economy would be in the toilet if the Fed never did anything to expand its balance sheet," said Michael Feroli, chief economist at JP Morgan and a former New York Fed staffer.


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