The Fed conducted QE4 from spring 2020 to early 2022, purchasing $4.6 trillion in securities and funding those purchases with a corresponding increase in its liabilities of bank reserves and reverse repos. In effect, the Fed’s balance sheet now appears similar to that of a hedge fund whose long-term assets are financed by short-term borrowing, except that such funds routinely hedge their interest rate risk whereas the Fed’s portfolio is effectively naked.
As the Fed has pushed up interest rates in its battle against inflation, the interest expense on the Fed’s liabilities is now far exceeding the earnings on its assets. And the Fed will continue to incur negative net interest income over the coming years. No congressional bailout will be needed to cover those losses; rather, the Fed will simply borrow the corresponding amount from the public. The Fed’s operations are not included in the federal budget, and hence its liabilities do not count against the debt ceiling limit.
Nonetheless, these costs will indeed be borne by taxpayers. Normally, the Fed earns a steady positive net interest income of about $100 billion per year, mainly reflecting the fact that the Fed doesn’t pay any interest on its liabilities of paper currency, and that net interest income is directly transferred to the Treasury. Since last fall, however, the Fed has stopped sending any remittances to the Treasury. Our analysis indicates that its remittances will remain suspended over the next five years and depressed for years thereafter.
The magnitude of these costs can also be assessed by considering the balance sheet of the consolidated federal government, including the Federal Reserve. (As an independent agency, the Fed’s operations aren’t included in the regular federal budget). During 2020 and 2021, the Treasury was auctioning large amounts of long-term notes and bonds to “lock in” the historically low cost of financing the federal debt. However, the Fed acquired a large fraction of those securities and funded its purchases with short-term liabilities, leaving the consolidated federal sector exposed to much greater interest rate risk. The Fed also purchased huge amounts of agency mortgage-backed securities (MBS) at a time when mortgage rates were at historic lows, and the yields on those securities are now far below the rates that the Fed is paying on its interest-bearing liabilities.
The Fed never alerted Congress or the public that its QE4 program could put taxpayers at risk. Indeed, the minutes of its monetary policy meetings provide no hint that Fed officials ever engaged in any substantive discussion of the costs and benefits of QE4. The initial phase of securities purchases did stabilize markets at the onset of the pandemic. However, those financial strains subsided within a few weeks, whereas the Fed continued engaging in huge purchases for nearly two years thereafter. We find no significant evidence that the continuation of such purchases had any substantial benefits. Indeed, the Fed’s MBS purchases may well have been counterproductive in exacerbating the housing boom over that period.
Transparency and accountability are not partisan issues. The Fed is an independent agency, but it must remain accountable to Congress and the public. In carrying out their role of overseeing the Fed, members of Congress should consider holding public hearings about QE4 and then consider potential legislative measures. For example, the Fed has had a longstanding exemption from reviews by the Government Accounting Office (GAO), the nonpartisan watchdog for all other government agencies. Henceforth, the GAO should be authorized to conduct regular reviews of all aspects of the Fed’s policies and operations. Similarly, the Fed’s inspector general should no longer be merely a Fed employee but should become a fully independent official, just like at every other major government agency. Such reforms can strengthen the Fed’s accountability while keeping its monetary policy decisions insulated from political interference.
Ordinary American families, who have been tightening their belts in response to high inflation, may well be outraged that an ineffective and opaque Fed program will have such a huge cost to taxpayers. Will the Fed be held accountable for its trillion-dollar bridge to nowhere?
