In a Marketplace analysis yesterday, the daily financial update reported how the Federal Reserve’s management of its multi-trillion dollar portfolio can reduce or increase the government’s overall operating deficit.
As reported, for the last 15 years the Fed’s been making about $100 billion a year a profit sent right to the Treasury which, as revenue, reduces the federal deficit.
The “profit” comes from the net spread between what the Fed earns on the trillions of bonds and mortgage-backed securities that it began purchasing during the financial crisis of 2008 under the policy of “quantitative easing.”
This macro economic policy continued and expanded during the Covid shutdown. The cost to carry these interest earning assets in the Covid era was near zero. The majority of funding was from the excess reserves banks kept with the Fed which was paying less than 1%.
Today that spread is upside down as the cost of funds has risen to nearly 5.5% on overnights. Rates on the portfolio are mostly fixed and at much lower yields as securities were purchased in a much different part of the interest rate cycle. Interest expense is now greater than interest income with the result that “the Fed has lost on the order of $100 billion since last fall,”
Here are the Fed’s total balance sheet holdings as of October 18, 2023 showing almost $8 trillion in total assets. Tables show that the majority of assets have maturities beyond ten years.
When the Fed has a loss, it files the loss away until it can pay it back once it’s making a profit again. This year’s “loss” will equal about 5% of the total government deficit. So instead of lowering the shortfall as in prior years, it adds to it.
The NCUSIF Analogy
The largest asset managed by the NCUA is the NCUSIF’s $22 billion investment portfolio. As of August 30, $4 billion was invested overnight with a yield of 5.4%. The remaining $18 billion was invested in maturities as long as seven years with a combined yield of 1.4%.
At month end the portfolio’s market value was $1.5 billion less than book. As short term investments become a greater portion of the total, the duration has declined slightly to 2.64 years. This is the approximate time that it would take the cash flows from the maturing investments to be at market–should the current yield environment become the new “normal.”
If the NCUSIF’s portfolio yield were 5% or greater, the fund’s total revenue would exceed $1 billion. This would result in dividends to the fund’s credit union owners. When the portfolio is below market for an extended period this shortfall comes out of credit unions’ pockets.
Time for Credit Unions to Be Alert
It will be critical for credit unions to monitor the monthly updates of the fund. The Agency’s upcoming investment decisions are critical. Its interest rate risk management and duration will have a critical impact on the Fund’s future. This includes total revenue, its financial soundness and credit unions’ bottom lines.