Steve Baker MP: The FED is Very Nearly Bust and it is Probably Not Alone amongst Central Banks

According to Steve Baker MP, a review of the US Federal Reserve’s own document reveals that the Federal Reserve, the US central bank is very nearly bust. Here is an extract from his article from 1st September 2011:

The size of the Fed’s balance sheet is now about $2,843 billion, up from about $800 billion three years ago. The huge increase in the Fed’s balance sheet stems from bailouts, quantitative easing, and other central bank “liquidity” operations. There’s been a massive change in the structure of the Fed’s assets too.

The Fed’s capital base is $71 billion. That represents about 2.5% of its assets, or a leverage ratio of 40 times its capital. This ratio would have been considered unthinkable prior to the crisis: it is about four times greater than that permitted by the new Basel proposed rules for commercial banks and simply demonstrates that the bailout format and quantitative easing do not make these problems go away. If the patient has been incorrectly diagnosed, taking the wrong medicine will not cure him.

This capital to asset ratio means that a loss on its assets of 2.5% would be enough to make the Fed, by any normal standard, insolvent – unable to pay its debts. So how plausible might such a loss be?

… The Fed and the Bank of England both fear the revelation to the public of the truth: that the bank bailout and QE has not worked, that the commercial banks refuse to lend to each other out of solvency concerns and that this systemic toxicity has now infected the central banks.

Were the two central banks to raise rates by a modest degree, then the fig leaf of solvency would fall to the floor and reveal this naked truth. That is why specious arguments are ventilated about the risk of price deflation when both countries risk accelerating inflation. These arguments are used to justify near zero interest rates, imperilling both countries’ hopes of lasting economic recovery.

You can read the whole article here.