The Federal Reserve purchased large amounts of government bonds and mortgage bonds to support the economy and financial markets during the COVID crisis, which has led to concerns that it is technically bankrupt.
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Behind closed doors, the report is already making the rounds in expert circles: if you follow the rules of sound commercial accounting, the United States Federal Reserve (Fed) has lost its equity and is, as common language would have it, bankrupt. What happened?
During spring 2020 (i.e., in a period of extremely low interest rates), the Fed purchased large amounts of government bonds and mortgage bonds to support the economy and financial markets during the covid crisis.
The Fed paid for the purchases by issuing vast amounts of new central bank money. This has created an enormous “money surplus” in the US interbank market, where banks lend money to one another. It is exactly in this market where the interest rates for all other credit markets are determined.
However, the excess money supply now exerts strong downward pressure on the interbank interest rates. Since this is not desirable from a monetary policy point of view—after all, the Fed is raising the key interest rate with the intention of making interbank credit more expensive, slowing down economic growth, and lowering inflation—the Fed’s Open Market Committee has decided to pay interest on the excess balances that the banks hold at the Fed.
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This interest rate is currently 5.15 percent. This is close to the Fed’s official key interest rate, which is currently between 5.00 and 5.25 percent. In doing so, the Fed has set an interest rate limit in the interbank money market: no bank can lend its excess money supply for less than 5.15 percent if it gets this rate from the Fed.
In addition, the Fed grants “privileged nonbanks” the opportunity to conclude so-called reverse repurchase agreements with the Fed—this select group includes asset managers, investment companies, pension funds, and others. This agreement allows them to transfer the balances they and their customers do not need to the Fed “overnight” in exchange for interest-bearing securities. In return, they earn an interest rate of 5.05 percent, slightly below, but still close to, the minimum interest rate on the interbank market.
According to data from the US Treasury, California owes the most debt at $18.6 billion and has defaulted on it.
The Fed exists due to bank runs during the early 20th century, so GGI should provide more details. It’s no exaggeration that modern banking and compound interest underlie current world civilization.
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