A notably bad idea, but one which has precedent

Published in the Financial Times.

Among current “wild ideas” Gillian Tett writes (“Threats to the Fed go beyond firing Powell”, Opinion, July 19) that President Donald Trump may ask Scott Bessent, the Treasury secretary, to head the Federal Reserve too.

I agree that it is a notably bad idea to have the borrower be the boss of the lender, particularly to have the world’s biggest borrower, the US Treasury, be the head of its most important lender, the Fed.

But historical clarity requires us to realise that the first chairman of the Federal Reserve Board was none other than the then Treasury secretary, William G McAdoo.

Indeed, under the original Federal Reserve Act of 1913 until the amendments of 1935, the Treasury secretary was by law automatically the chairman of the Federal Reserve board.

That was how President Woodrow Wilson and the Congress designed it.

Alex J Pollock
Senior Fellow, Mises Institute, Auburn, AL, US

No Easy Exit Emerges for the Federal Reserve as It Runs Up Mind-Boggling Losses

Published in The New York Sun.

There’s no rabbit to pull out of any hat when it comes to cutting the Fed’s interest expense.

The Federal Reserve’s accumulated operating losses reached $234 billion as of July 2. A mind-boggling sum. Subtracting these losses from its paid-in capital and retained earnings, which together total $46 billion, shows the central bank’s real capital is negative $188 billion.

Meaning — its losses have run through all the capital its private bank shareholders invested and the associated retained earnings five times. This is embarrassing for the greatest central bank in the world, which certainly did not plan to lose this much money. Neither were these huge losses expected by Congress or by American taxpayers.

The Fed’s losses in excess of its capital are a cost to taxpayers. Its negative capital means it has borrowed and spent nearly $200 billion of public money without the approval of Congress, solely to which the Constitution grants the power to borrow money on the credit of the United States. The Fed took an enormous financial risk without the approval, and perhaps without the awareness, of Congress.

The Fed’s losses reflect the simple fact that the interest expense it pays, primarily on the deposits held with it by private banks (often called “reserves”), is far greater than the interest income it earns on the $6 trillion of investments it bought mostly at the top of the market in bond prices, a market top created by its own buying. This means that the Fed bought at the bottom of yields on those bonds.

The result is that in, say, 2024 the Fed had $159 billion in interest income, but $227 billion in interest expense, of which $186 billion or 82 percent of this expense was interest paid on its deposits from banks. It lost $68 billion even before paying any of its operating expenses, and had a net loss of $77 billion for the year.

A temptingly simple solution to the losses comes to mind. As suggested by Senator Cruz, just stop paying interest to the banks on their deposits. In 2024, this would have reduced the Fed’s expenses by $186 billion, flipping its $77 billion loss to a pro forma net profit of $109 billion.

As Mr. Cruz rightly points out, for most of its history the Fed paid no interest on its deposits. Indeed, from its founding in 1913 to 2008, or for 95 years, the Federal Reserve Act prohibited Federal Reserve Banks from paying any such interest, so the private banks automatically got zero interest on their Fed accounts.

Naturally, the banks did not like this, viewing it not unreasonably as a tax. They finally succeeded in getting the law changed, then the change accelerated with the support of the Fed, which was about to launch an unprecedented expansion of its balance sheet and wanted the banks to be happy holding far bigger deposits with it than ever before.

The banks now have about $3.3 trillion in deposits at the Fed. In June 2008, still under the old system, the total Fed deposits from banks were only $13 billion. The banks’ deposits with the Fed are now more than 250 times what they were then.

At this point, the Fed is paying on its $3.3 trillion in deposits from banks at an interest rate of 4.4 percent. This means it incurs an annualized cost of $143 billion; dropping that expense would easily make the Fed profitable again going forward. In the first instance, the government would like the Fed, and therefore the government, to keep that money.

Then what would happen, though? If the banks didn’t like getting no interest on $13 billion, imagine how they would hate getting none on $3.3 trillion. Their income would just have dropped by $143 billion a year.

Each individual bank would try to get out of its now zero-income deposits by investing in something else. It might buy Treasuries or other securities, invest in mortgages, make new loans of all different kinds, or all of the above.

As all of the banks did this together, interest rates would fall in an inflationary credit expansion. The Federal Reserve would have lost control of interest rates, which it would not accept, since one of its essential roles is to be the national price-fixing committee for interest rates.

Because of the magic of a fiat currency central banking system, no matter how much the individual banks reduce their individual Fed deposits, the aggregate banking system cannot reduce its aggregate Fed deposits. They would still be $3.3 trillion unless the Fed itself reduced them. The government would have forced the banks as a whole to provide it with $3.3 trillion of free funding. It would be fair to call this financial oppression.

The Fed could reduce its deposits by selling its own investments and shrinking its balance sheet. Yet the Fed has a nearly $1 trillion unrealized loss on its investments. By selling it, the central bank would realize large losses — not to mention driving the market against itself.

The Fed will not do this. So in sum, considering Mr. Cruz’s idea leads to the conclusion that there is no easy way out of the upside-down financial position the Fed has gotten itself in.

What's the secret behind America's entrepreneurial success?

Hosted by The Citizen Farmers.

ALEX J. POLLOCK, former Trump administration Treasury official, board member of the Chicago Mercantile Exchange, and current Senior Fellow at the Mises Institute talk joins The American Stewardship Podcast to talk discuss, among other things...

• The Book & Bust Cycle...is it inevitable? Is it bad?

• How the U.S. Constitution fuels American innovation

• The pros and cons of the Federal Reserve

https://mises.org/profile/alex-j-pollock https://www.thecitizenfarmers.org/

Fannie Mae and Freddie Mac’s public risk could become private profit again

Published in The Hill and RealClear Markets.

Fannie Mae and Freddie Mac are the dominant companies in U.S. housing finance, which is the biggest credit market after government debt. They are huge, with combined assets totaling $7.8 trillion.     

Fannie and Freddie used to be government-sponsored enterprises. This privileged status led both of them to great financial success, combined with formidable political clout. Fannie, in particular, was a notable Washington bully.  

But having taken on excessive credit risk in the great housing bubble, they both failed in 2008, were put into and remain in government conservatorship, meaning total government control, and were bailed out by $190 billion in stock purchases by the U.S. Treasury, which means the government became and remains their dominant equity investor.

So, Fannie and Freddie are no longer government-sponsored enterprises and have not been since 2008. Now, they are instead government-owned and government-controlled entities.  

Former Rep J.J. Pickle (D-Texas) perfectly summed up the essence of Fannie and Freddie, and the key concept of a government-sponsored entity, a generation ago: “The risk is 99 percent public and the profit is 100 percent private.”

This government-sponsored enterprise combination is economically undesirable but highly tempting to politicians and highly attractive to the investors whose profits expand from receiving the government subsidy involved.

This handsome subsidy is cleverly achieved by creating a corporation with private shareholders who get the profit, but which also has a guarantee of its obligations provided for free by the U.S. Treasury, and therefore by the taxpayers.  

When things go well, the huge value of using the government’s credit flows through to the shareholders, while the Treasury and the taxpayers are stuck with the risk and the cost of any failure. What an investment opportunity!

So it is no surprise that some large investors are trying to get Fannie and Freddie made back into government-sponsored enterprises, the stock of which these investors could own, thus reaping billions per year from subsidies created by the government guarantee.  

The Trump administration has expressed support for this investment idea, and the president himself has supported the government guarantee involved. There has been a related run-up in the price of the portion of Fannie and Freddie equity still in private hands.

Of course, those who want to bring back Fannie and Freddie as government-sponsored enterprises have to address a tricky element of the guarantee from the government, because they need it to be real and fully believed in by the global purchasers of their mortgage-backed securities and debt. 

But at the same time, the Treasury needs to keep Fannie and Freddie off the government’s books by pretending it isn’t really a guarantee. Can they achieve both?       

A solution to this conundrum was found in 1968, when the Johnson administration, faced with rising deficits and debt from the rapid expansion of both war and welfare, wanted to get Fannie off its books, while at the same time expanding mortgage credit. 

Its solution was to make Fannie’s stock owned by private investors, but to provide government support that the market would accept as a guarantee, without issuing a formal guarantee. In the words of a memorandum of that time, held today in the Lyndon B. Johnson Library, this would “constitute indirect — but explicitly, not direct — Federal guarantees.”

With this idea, it turned Fannie into a government-sponsored enterprise. Then Freddie was created in 1970.      

So, “explicitly not direct” was the resulting guarantee that Fannie and Freddie were required by statute to include in each of their offering memoranda that “securities, together with interest thereon, are not guaranteed by the United States and do not constitute a debt or obligation of the United States.”

That seems clear, but nobody at all believed it, and because nobody believed it, the Johnson administration’s scheme worked. 

Fannie and later Freddie and their debt were kept off budget while they mightily expanded until their 2008 collapse. At that point, the reality of the guarantee was decisively demonstrated by the complete protection of all creditors of the insolvent companies, even subordinated debt holders.

What now? The worst case would be to turn Fannie and Freddie back into government-sponsored enterprises again, with a free government guarantee to subsidize the investors.

Theoretically, a good outcome would be to return to private ownership, but also require Fannie and Freddie to pay a fair market price for their government guarantee. Unfortunately, as Ed Pinto and I have shown, the fair price for the guarantee is so high that the stock becomes unattractive to investors.

Fannie and Freddie are far too big to fail, so the government cannot get out of its “implicit” guarantee. It looks like the best case at this point is to leave them as government-owned and government-controlled entities, while steadily working to shrink their distorting impact on housing markets, their risk to taxpayers and the inflation of house prices they cause.

The Federal Reserve Is Covering Up Its Financial Losses

Published by The Mises Institute’s Radio Rothbard.

Alex Pollock, an expert on Federal Reserve policy, joins us to talk about how the Fed has backed itself into a very bad financial corner, and there is no painless way out.

Duplicity at the Fed

Published in Law & Liberty with Paul H. Kupiec

The Federal Reserve is losing billions of taxpayer dollars, and concealing this through dubious accounting practices.

The Federal Reserve System has unique powers among Congressionally-chartered government bodies, and yet its powers do not include the authority to borrow money at taxpayer expense to pay for huge accumulating losses without Congressional approval. The Fed has invented its own unique financial accounting standard to disguise the fact that, under normal accounting rules, the system is deeply insolvent. From 2022 through 2025, the Fed system’s accumulated losses have completely consumed the system’s capital and forced the Fed to borrow over $185 billion more than the Fed owns in assets just to pay its bills—a fact it intentionally tries to hide from the public.

Rather than earning seigniorage profits for taxpayers, something the Fed did for more than 100 years, the present-day Fed has instead accumulated losses of the staggering amount of $231 billion. These losses reflect Fed expenses that, between 2022 and 2024, included over $420 billion paid to banks in interest on their deposits held at the Fed and over $185 billion in interest paid to other financial institutions on repurchase agreement loans; in addition, the Fed made over $4 billion in dividend payments to Fed member banks on their Fed district bank stock.

However unique, the Fed ultimately is a government agency. When it is making losses, the Fed’s annual expenses are paid by taxpayers and are a direct cost of running the government. When Fed expenses exceed Fed revenues, the Fed borrows to pay its bills. When accumulated Fed losses exceed the Fed’s capital—as they do today—the amount the Fed has borrowed in excess of the value of the Fed’s assets is a contingent taxpayer liability.

Under current accounting standards, neither Fed cash losses nor the taxpayer contingent liability created by accumulating Fed losses are reflected in the annual federal budget. This is problematic. The Fed should be transparent and accountable to taxpayers for its expenditures, just like any other federal agency—but it clearly is not. There is a simple, if politically difficult, two-part solution: (1) The Fed should be required to prepare its financial statements using generally accepted accounting standards; and, (2) The Fed’s consolidated system operating costs and the contingent taxpayer liabilities associated with its negative capital should be reported in the notes to the annual federal budget.

The Fed constantly asserts its “independence.” Fed independence may be interpreted to mean that, except in national emergencies, the Fed should be permitted to set interest rates without executive branch interference. The president and designees are free to express displeasure with the Fed’s monetary policy, but they should not be allowed to force the Fed to adopt a particular monetary policy preferred by the president.

However, the Fed remains unquestionably accountable to Congress, which retains plenary oversight responsibility and authority over it. Congress is not only free to criticize any aspect of the Federal Reserve, but also to pass legislation to direct how the Fed conducts monetary policy, manages its risk, accounts for its results, or discharges any of its other duties. As Thomas McCabe, then Chairman of the Federal Reserve Board, expressed with great clarity: “The Federal Reserve Act … provided that the Federal Reserve should have independent status in the government structure, reporting directly to the Congress.”

Until recently, consolidated Fed system revenues exceeded its operating expenses and member bank dividend payments, allowing the Fed to remit billions of dollars to the US Treasury each month. Now, the Fed has enormous and continuing cash operating losses. By May 28, 2025, the Fed’s operating losses have accumulated to reach a mind-numbing value of $231 billion.

There is no explicit provision in the Federal Reserve Act or other law that empowers the Fed to borrow money at taxpayer expense, off the books of the Federal government, to pay expenses in excess of Fed income without Congressional approval. Yet the Fed has been doing exactly that since March 2023, when its accumulated losses surpassed its total capital. To date, the Fed’s liabilities exceed the book value of its assets by $185 billion. The Fed has had to borrow this amount to pay its expenses and to pay dividends to its private shareholders, while it has no profits and no retained earnings.

Fed member bank dividends are cumulative by law. However, the act of borrowing to pay rather than cumulate dividends payable puts member bank interests ahead of taxpayers. Moreover, the payment of dividends in the absence of revenues in excess of expenses seemingly violates the Federal Reserve Act, which explicitly conditions member bank dividend payments: “After all necessary expenses of a Federal reserve bank have been paid or provided for.” Under this requirement, if the Fed is losing money after paying its expenses, there is obviously nothing left to pay dividends.

Instead of reporting its financial results in a forthright manner, the Fed adopted nonstandard accounting practices to hide the financial impact of its accumulating cash losses. It classifies its accumulating cash losses as a “deferred asset” so that its reported retained earnings remain unchanged despite its massive losses. The Fed uses accounting rules of its own creation to obscure the fact that the consolidated Federal Reserve System has negative capital and is borrowing scores of billions of dollars off-budget to pay interest and dividends to banks and other financial institutions.

In short, the Fed’s accounting pretends that its losses are an asset and that its losses do not reduce its capital. The Fed adopted this accounting practice in 2011 when it recognized that its massive “quantitative easing” securities purchases could potentially create Fed losses under its post-financial crisis policy of paying interest on bank reserves, as indeed they did in time. Its solution was “just change the accounting” so cash losses would misleadingly appear not to affect the Fed’s capital. To add insult to injury, the Fed’s annual operating expenses and accumulated borrowings are not included in official federal budget accounts, even though these borrowings are ultimately a taxpayer liability resulting from a real federal government operating expense.

Congress explicitly delegated the power to set the accounting standards used to prepare the financial statements of the government agencies that are consolidated in the federal budget to the Federal Accounting Standards Advisory Board (FASAB). The FASAB designed its accounting standard to facilitate public evaluation of each reporting entity’s services and costs as well as the management of its assets and liabilities, thereby ensuring that the entity’s officials are “publicly accountable for monies raised through taxes and other means.” The Government Accountability Office, the Office of Management and Budget, and the Treasury Department are jointly responsible for overseeing the FASAB.

For federal budget accounting purposes, the FASAB classifies the Fed as a “disclosure entity”—an entity whose budgetary impact is recognized only in the notes to federal government consolidated accounts, and in the Fed’s case, recognized only to the extent that it remits revenues to the US Treasury. The Fed’s operating expenses are not separately disclosed.

If you peruse the notes to the consolidated federal budget financial statements and are not deeply invested in legal minutiae, you might think that the consolidated Federal Reserve System made money in 2023 and 2024. By law, Fed remittances to the Treasury are made separately by the twelve district reserve banks, and only a few district reserve banks had revenues that exceeded expenses and dividend payments in 2023 and 2024. These cash remittances to the Treasury were overwhelmed by tens of billions of cash operating losses at the remaining federal reserve district banks, and yet the Fed’s consolidated cash losses, despite being an undeniable cost of government, do not appear anywhere in the notes to the combined federal budget accounts.

While the FASAB does not set accounting standards for disclosure entities, regulators have required federal government-sponsored corporations such as the Federal Home Loan Banks, Fannie Mae, and Freddie Mac to use Securities and Exchange Commission-approved public accounting standards when preparing their financial statements, notwithstanding the fact that they, too, are federal budget disclosure entities. As far as we can determine, the Federal Reserve’s claim that it has the power to determine its own accounting standards without the external input or approval of a duly designated accounting standard-setting body is unique among large federal budget disclosure entities.

The private ownership of the stock of the Federal Reserve’s district banks explains why the Fed is not consolidated in federal budget accounts. The stock of the twelve district Federal Reserve banks is 100 percent owned by their private member banks. The shareholders elect two-thirds of each bank’s board of directors, which appoints the president of the bank with Federal Reserve Board approval. These privately owned twelve district banks hold member bank deposits, issue Federal Reserve Notes, borrow on repurchase agreements, lend to banks, process vast payment transactions, invest a combined more than $6 trillion in Treasury debt and mortgage-backed securities, and generate the combined Federal Reserve System profits or losses.

The combined operating loss of $231 billion so far suffered by the Federal Reserve banks has accrued because the interest the Fed pays on deposits and borrowings vastly exceeds the interest it earns on its assets. For the combined system and nine of the twelve district banks individually, the accumulated operating losses by far exceed the paid-in capital and surplus, making nine district banks and the system technically insolvent on a GAAP basis.

Under the Federal Reserve Act, the stockholders of the insolvent district reserve banks—Federal Reserve member banks—are in part liable for the capital shortfall of their insolvent district bank. According to the Act, should there be a need to fortify any Federal Reserve district bank’s resources, member banks are subject to call on the second half of their equity subscription [12 U.S.C. § 282]. For the Fed shareholders in total, the amount subject to call is $39 billion. The Federal Reserve Board could simply issue a call for this additional capital, and the Fed member banks would have to comply.

In addition, the Act includes the little-known shareholder contingent liability that member banks may be required to contribute an additional amount to cover district reserve bank operating losses up to an amount equal to their membership subscription [12 U.S.C. § 502]. This would be an assessment, not a stock purchase. For Fed shareholders in total, the current maximum potential assessment is $78 billion. The Fed needs only to say, “Send us the money!”

But the Fed has not exercised its authority either to call additional member bank capital contributions or to impose assessments authorized by the Act to make up for some of the losses. Instead of raising capital, the Fed created its nonstandard accounting that allows it to hide the fact that the combined system and nine of the twelve district banks are GAAP insolvent. Unbelievably, the book surplus account balances the Fed reports are not reduced by its giant operating losses, thanks to the “deferred asset” gambit. The dividends to member banks that the Fed keeps paying despite the lack of profits and negative real capital are also treated as part of the ignominious “deferred asset.”

While the Fed’s published financial statements suggest that operating losses can be covered merely by creating an accounting entry, the “deferred asset,” in reality the Fed raises the money that corresponds to this deferred asset by issuing new Federal Reserve Notes, or borrowing from banks in the form of deposits, or borrowing from nonbanks through repurchase contracts, or letting assets mature and using the cash to pay expenses and dividends while not reducing the corresponding borrowings.

All of these actions increase the debt of the consolidated US government and are real costs to the taxpayers, even though consolidated federal budget accounting does not recognize these costs.

Federal Reserve Notes are explicitly guaranteed by the US government and must by law be collateralized by the Fed, but deposits in a district Federal Reserve bank are neither guaranteed nor collateralized, nor are they joint obligations of the other district banks. These deposits would legally be subject to losses without additional shareholder contributions and/or taxpayer support. The fact that Fed member banks maintain trillions in deposits at GAAP insolvent Federal Reserve district banks demonstrates that member banks believe that their deposits are fully protected by an implicit federal government guarantee, as indeed they are. Thus, the Federal Reserve’s negative capital position, which has been created over time by paying banks and other financial institutions more in interest and dividend payments than the Fed’s income, is in fact a taxpayer liability.

The Federal Reserve should not be permitted to make up its own accounting rules in order to hide its losses and negative capital. Taxpayers should demand that Congress require that the Fed produce financial statements that conform to generally accepted accounting standards, and that the notes to consolidated federal budget accounts report Fed operating losses and member bank dividend payments separately from Fed remittances to the Treasury. Such disclosures are necessary to promote public accountability and accounting probity for all parts of the government, which includes the Fed.

The current Federal Reserve accounting standard and federal budget disclosures hide taxpayer material financial risk created by the operations of the Federal Reserve, with its losses of $231 billion and negative capital of $185 billion. They also obscure the interests and potential liability of the private shareholders of the Federal Reserve district banks, which compete with taxpayers’ interests and should be accurately represented in the Fed’s reported capital accounts.

Who might object to our straightforward proposed changes in Fed and federal government accounting standards? Why the Fed, banks, financial institutions, and perhaps even some in Congress—who are unwilling to strengthen Fed oversight. Notwithstanding the almost certain political push-back, these changes are needed as the Federal Reserve is far too important to the US government and the country to continue using its current duplicitous accounting practices.

After more than fifty years of U.S.government-sponsored housing finance, why has home ownership not increased and why are houses unaffordable?

Published in Housing Finance International Journal.

The U.S. housing finance system is unique in the world by being dominated by the Government-Sponsored Enterprises (GSEs), Fannie Mae and Freddie Mac. GSEs are a really poor and dangerous idea. By definition, they combine private ownership of their stock with special privileges, including most importantly a guarantee of their obligations by the government, i.e. the taxpayers. This guarantee is said to be only “implicit,” but is fully real, as history demonstrates. It naturally leads to overexpansion of mortgage credit and inflation of house prices.

Fannie was made into a GSE in 1968. Freddie was created as a GSE in 1970. Thus, we in the U.S. have had for well over half a century these two expanding government-guaranteed and government-subsidized attempts to increase home ownership and make it more affordable. But the home ownership rate has increased by only 1 percentage point during that long time.

Over the last five decades, the GSEs became enormous: Fannie’s total assets are $4.4 trillion as of March 2025, and Freddie’s are $3.4 trillion, giving them combined assets of $7.8 trillion. That’s “trillion” with a “T.” All the risk is guaranteed by the government. The GSEs are a huge and distorting commitment to housing finance which burdens our over-indebted government’s credit, although the partial private ownership allows the GSE obligations to be kept off the government’s books.

Fannie and Freddie have been majority-owned by the U.S. Treasury since they were bailed out by the government in the panic of 2008, and the Treasury has an option to acquire up to 79.9% of their common shares for the price of $0.00001 per share—in other words, essentially for free. But both these GSEs still have private shareholders, too. Various proposals to make Fannie and Freddie’s stock fully privately owned have been and are being made, but this would not change the fundamental problem at all: they would still be GSEs.

In addition to the giant Fannie and Freddie, there is much more government intervention and risk-shifting to the taxpayers in the U.S. housing finance system. There is Ginnie Mae, also created in 1968, which is a government corporation, with 100% of its stock owned by the U.S. Treasury. Ginnie as of March 2025 guarantees $2.7 trillion (again with a “T”) of mortgages and is itself fully guaranteed by the taxpayers.

If we add Fannie, Freddie and Ginnie together, we find these government-guaranteed organizations represent the staggering sum of $10.4 trillion. In round numbers, the U.S. government guarantees $10 trillion out of total outstanding residential mortgages of $14 trillion: in other words, the government guarantees about 70% of the mortgage credit in the country. In my opinion, this is financially ridiculous: no national mortgage market worthy of the name should have to be 70% government guaranteed.

There is more U.S. government mortgage presence on top of that. The Federal Home Loan Banks (FHLBs), which are also GSEs, lend money to finance the holding of mortgages by financial institutions. The FHLBs have total assets of $1.2 trillion. The $1.1 trillion in debt they issue to fund themselves is also guaranteed by the government. This brings the total government backing of housing finance to about $11 trillion.

Then there is the Federal Housing Administration (FHA), the government’s official sub-prime mortgage lender. It insures the credit risk of higher risk mortgage loans, with insurance in force of about $1.5 trillion. The Veterans Administration provides mortgage credit insurance to members and veterans of U.S. armed services. There are about $1 trillion in loans with VA insurance. Any deficits of the FHA and VA programs are funded by the Treasury. Since most FHA and VA loans are securitized by Ginnie, which adds its guarantee to their insurance, they are for the most part already included in the Ginnie numbers.

Finally, the U.S. central bank, the Federal Reserve, is a huge investor in residential mortgages, with $2.2 trillion on its balance sheet at the end of April 2025. In my opinion, the Fed should own zero mortgages, but instead it owns about 15% of the entire market. The Fed buys mortgages in the form of securities guaranteed by Fannie, Freddie and Ginnie, so the government had the credit risk already. But by buying them, the Fed adds to the credit risk an enormous interest rate risk to the government, since it makes 30-year fixed rate investments and funds them short. I estimate that this now upside-down interest rate risk gamble has lost approximately $100 billion so far for the Fed, which means also for the government and the taxpayers—and continues to lose about $40 billion a year.

What has the massive U.S. government intervention in mortgage lending achieved in the way of improved home ownership? The U.S. home ownership rate was about 64% in 1970 and it is 65% in 2025. It has hardly increased in 55 years, all the government and government-sponsored housing finance notwithstanding.

The government intervention has, however, helped inflate two 21st century house price bubbles. The first peaked in 2006 and led to the financial crisis of 2007-09. The second sent average house prices far above their 2006 peak, including rising at over 18% in 2021. This has led to their continuing unaffordable levels, especially for young families trying 22 HOUSING FINANCE INTERNATIONAL Summer 2025 Regional round up: news from around the globe to buy their first house. Although the rate of increase has now become moderate, average house prices are still rising, at the annualized rate of 3% in April 2025. With inflation at 2.3% for that month, average house prices are also still going up in real terms.

It is often observed that U.S. house prices are simply too high, which helps explain why sales of existing houses in 2024 were the fewest since 1995, even though the population is 27% larger than then.

We can conclude that the vast scale of U.S. government intervention in guaranteeing and subsidizing of mortgage debt has been a mistake. The housing finance system should grow more private, with the market share of the GSEs being systematically reduced and the government’s overall role getting smaller. The Federal Reserve’s target for investment in mortgages should be zero. The government should target a substantial reduction in the percentage of the mortgage market it guarantees. As a first estimate, I recommend a reduction to 20%, down from the current egregious 70%.

Event video: The Great Debate: How to Modernize Financial Regulation and Create Economic Stability in a Digital Age

See the event information here.

Join George Mason University’s (GMU) Center for Assurance Research and Engineering (CARE), the Financial Technology & Cybersecurity Center (Center), GMU’s School of Business, and a host of experts for a wide ranging discussion of what a financial regulatory structure equipped to deal with the realities of today’s financial services sector should look like.

The Great Debate:  How to Modernize Financial Regulation and Create Economic Stability in a Digital Age

Co-Chairs:

Dr. Jean-Pierre Auffret
Director, Research Partnerships, Costello College of Business, George Mason University; Director, Center for Assurance Research and Engineering (CARE), College of Engineering & Computing, George Mason

Thomas P. Vartanian
Executive Director of the Financial Technology & Cybersecurity Center
Author, 200 Years of American Financial Panics, Crashes, Recessions and Depressions, And the Technology That Will Change It All; The Unhackable Internet: How Rebuilding Cyberspace Can Create Real Security and Prevent Financial Collapse

Agenda:

8:30 – 8:40 a.m. Welcome and Overview

8:40 – 9:10 a.m. Why Don’t We See Financial Sector Crises Coming & How Do We Make Supervision Work Better?

Keynote Remarks:
Elizabeth McCaul
Former Member Supervisory Board, European Central Bank
Former Chair, New York State Banking Board and Superintendent of Banks

9:10 – 10:10 a.m. Panel:

Greg Baer
President & CEO, Bank Policy Institute
Gary Gorton
Professor Emeritus of Management & Finance
Yale School of Management
Author, Misunderstanding Financial Crises: Why we don’t see them coming
Elizabeth McCaul
Alex Pollock
Senior Fellow, Mises Institute

10:10 – 10:35 a.m. In Person Exclusive: Faculty Donut Networking Break
featuring Elizabeth McCaul, William Isaac, Randal Quarles

10:35 – 11:25 a.m. Time to Regulate Cryptocurrency? Investments, Money or Both?

John Reed Stark
John Reed Stark Consulting LLC
Former Chief, SEC Office of Internet Enforcement
Coy Garrison
Partner, Steptoe LLP
Former Counsel to SEC Commissioner Hester Peirce

11:25 a.m. – 12:25 p.m. Regulation of Nonbank Financial Institutions and FinTechs

Michele Alt
Co-Founder and Managing Director, Klaros Group
Dan Swislow
Director of Policy and Government Affairs, Mercury
Caitlin Long
Founder & CEO, Custodia Bank

12:25 – 1:40 p.m. Buffet Lunch

12:40 – 1:20 p.m. Fireside Chat

Randal Quarles
Chairman & Founder, The Cynosure Group
Former Vice Chair for Supervision, Federal Reserve Board
Thomas Vartanian

1:40 – 2:40 p.m. Building a New Regulatory Model

Elizabeth McCaul
Todd Zywicki
George Mason University Foundation Professor of Law
George Mason University, Antonin Scalia Law School

[Additional panelist to be announced]
2:40 – 3:05 p.m. In Person Exclusive: Faculty Donut Networking Break
featuring Robert Ledig, Elizabeth McCaul, Todd Zywicki

3:05 – 3:40 p.m. Rethinking Deposit Insurance – Uninsured Deposits and other Threats to Financial Stability

Keynote Remarks:
William Isaac
Chairman, Secura/Isaac Group
Former Chairman FDIC

3:40 – 4:30 p.m. Panel:

Robert Ledig
Managing Director, Financial Technology & Cybersecurity Center
Alison Touhey
SVP, Bank Funding Policy, American Bankers Association
Richard Wald
Vice Chairman, Emigrant Bank

4:30 – 5:15 p.m. Leveraging AI to Improve Financial Regulation

Jo Ann Barefoot
CEO & Cofounder at Alliance for Innovative Regulation
Author, The case for placing AI at the heart of digitally robust financial regulation
Dr. Jon Danielsson
Director of the Systemic Risk Centre, London School of Economics
Author, The Illusion of Control: Why Financial Crises Happen and What We Can (and Can’t) Do About It

[Additional panelist to be announced]
5:15 – 5:30 pm Wrap Up

Penny-Ante Inflation?

Quoted in The New York Sun:

That’s because under a fiat money regime, currency loses any relation to the value of the circulating medium. The cost of the metals that now comprise a penny — mostly zinc, with a dash of copper — now exceeds the face value of the coin. “The demise of the penny,” a former Treasury official, Alex Pollock, a Sun contributor, tells Mr. Grant’s newsletter, “is a pointed reminder of the Federal Reserve’s unrelenting depreciation of the U.S. currency.”

Mr. Pollock takes 1950 as a point of comparison to explain the penny’s fate. In the 75 years since then, he says, “the purchasing power of a penny has dropped by 93 percent,” meaning that today’s coin “is worth about 1/13 of a 1950 penny.” He traces the penny’s doom to the fact that “nobody in 1950 thought they needed a coin worth 1/13th of a cent and we don’t need a coin of such little value, either.”

Following this logic, Mr. Pollock adds that “a nickel in 2025 is worth about 3/8 of a 1950 penny, and a current dime is worth 25 percent less than the former penny.” Is the writing on the wall for these coins, too? “With the Fed’s earnest promise of perpetual inflation, we soon won’t need nickels and dimes,” Mr. Pollock reckons. “Meantime, the current quarter is worth 1.8 pennies of 1950,” he adds.

So it is that, in Mr. Pollock’s telling, “the Fed has transformed two bits into less than two cents.” He marvels that “continuous inflation has remarkable shrinking power.” It marks the vindication, too, of a warning in 1966, in the twilight years of honest money, by National Review’s William Rickenbacker. He lamented how America had just removed the silver from its coinage, “practically unchanged from the birth of the republic.”

Letter: Questions need to be asked about the Federal Reserve’s losses

Published in the Financial Times.

Brian James Gross’s loyal defence of the Federal Reserve’s losses (“Why commercial banking logic won’t apply to the Fed”, Letters, May 31) doesn’t ever mention the egregious amount of these losses — $231bn at the end of May and still growing — but it does get one thing right: that the Fed is not “a” bank. No, the Fed combines 12 government-sponsored banks, each of which has loans, investments, deposits, profits or losses, and stockholders that are private banks.

The stockholders have contributed a combined $39bn in paid-in capital, on which they expect and so far do receive dividends; they might be surprised to find out that their capital is “irrelevant”. In nine of the 12 Federal Reserve banks, the losses exceed the total capital.

These losses are not mere “accounting losses”, but cash operating losses. The losses are an expense to the consolidated government and to the taxpayers, and increase the national debt. In addition, the 12 banks have about $1tn in mark-to-market losses on their investments, suggesting more operating losses in the future.

The Federal Reserve is a profit-seeking entity, though not a profit maximiser, intentionally designed to make money for the government by issuing non-interest bearing currency and investing in interest-bearing assets. That the combined Federal Reserve banks instead are now losing so much money is because they took enormous interest rate risk, lending long and borrowing short, and are upside down on the trade.

The Fed, with its component banks, is not “sovereign”, nor does it have “autonomy”, as Gross suggests (although it wishes it did!), but is entirely accountable to and subject to the elected representatives of the people in Congress assembled. Congress should surely, just as Brendan Greeley said in the original FT opinion piece, be making judgments about the Fed’s losses — how they are deficit-increasing and national debt-increasing, whether Federal Reserve banks should continue to pay dividends when they have no profits, and whether something needs to be done about the Fed’s capital, which on a combined basis is in reality negative $185bn.

Alex J Pollock

Senior Fellow, Mises Institute,

Lake Forest, IL, US

Art of Default

Published in Grant's Interest Rate Observer.

"The demise of the penny," reader Alex J. Pollock reflects,

is a pointed reminder of the Federal Reserve's unrelenting depreciation of the U.S. currency. Taking 1950 as a convenient starting date, that being 75 years or about one lifetime ago, the purchasing power of a penny has dropped by 93% as the Consumer Price Index has gone in round numbers from 24 to 321, so a penny in 2025 is worth about ¹⁄₁₃ of a 1950 penny.

Naturally, nobody in 1950 thought they needed a coin worth ¹⁄₁₃ᵗʰ of a cent and we don't need a coin of such little value, either. A nickel in 2025 is worth about ³⁄₈ of a 1950 penny, and a current dime is worth 25% less than the former penny. With the Fed's earnest promise of perpetual inflation, we soon won't need nickels and dimes. Meantime, the current quarter is worth 1.8 pennies of 1950: The Fed has transformed two bits into less than two cents. Continuous inflation has remarkable shrinking power.

It’s Time for Shareholders of the New York Federal Reserve Bank To Receive a Call for Capital

The New York member of the Federal Reserve System has racked up by far the biggest losses in the Federal Reserve System.

Published in The New York Sun.

This column is about the capital deficit confronting the biggest among the 12 Federal Reserve Banks. Although we often refer to our central bank in the singular as the “Fed,” the system includes twelve different Federal Reserve Banks, each a separate corporation. Each has its own shareholders, directors, officers, balance sheet, profit and loss performance, and capital — or recently, absence of capital.

New York has always had a special and superior position, the most prominent and prestigious of the twelve Federal Reserve Banks. All other FRBs are required by statute to take turns serving as voting members of the Fed’s super-powerful Federal Open Market Committee, but New York has a permanent seat on the FOMC. Moreover, its president is always the Vice Chairman of the committee. New York carries out the open market buying and selling on behalf of the entire Fed.

In the early years of the Federal Reserve, the most influential officer of the System was Benjamin Strong, the Governor of the New York Fed 1914-1928 and “a dominant force in U.S. monetary and banking affairs.” Strong, for example, negotiated directly with the Governor of the Bank of England, the top central bank in the world until surpassed by the Fed.

Note the matching titles at that time. The heads of the individual FRBs were originally called “Governors,” after the style of the head of the Bank of England. In 1935 they had their titles downgraded to “president” so the members of the Federal Reserve Board could become “governors.”

New York is far and away the biggest FRB, with massive total assets of $3.4 trillion. This is more than all the other eleven FRBs put together, more than five times as big as the No. 2 reserve bank, San Francisco, and 67 times as big as the No. 12, Minneapolis. New York owns the most bonds and mortgage securities of any FRB and has the biggest naked interest rate risk position of long invested vs. short funded.

In recent times, New York has added another distinction, one less desirable. It has far and away the biggest losses and the most deeply negative capital of any FRB. Since the fourth quarter of 2022, the Fed on a combined basis has been losing previously unimaginable amounts of money — its aggregate operating losses as of the end of April 2025 are a staggering $228 billion.

Of that amount, the FRB New York alone has suffered operating losses of $137 billion, a disproportionate share of the Federal Reserve System. While it has 51 percent of the combined Fed assets, New York has 60 percent of the operating losses.

When the FRBs marked their investments to market at year-end 2024, the results of which they disclose but do not include in their financial statements, the combined Fed had a market value loss of more than $1 trillion. The FRB of New York alone had a market value loss on its investments of $572 billion, 54 percent of the System total.

The New York Fed shows on its official balance sheet extremely little capital relative to its huge assets, about $15 billion in capital or less than half a percentage point of assets. In reality, the $15 billion is not there — New York’s losses of $137 billion mean the capital has been lost nine times over. Fundamental accounting requires that losses be subtracted from capital, so the FRB New York’s real capital is $15 billion minus $137 billion or negative $122 billion. This is 66 percent of the System’s combined negative capital.

What should the stockholders of the FRB New York think? They own equity in a technically insolvent corporation. They are still getting dividends from their FRB, but while such dividends are required by law to come from profits, there are no profits and there is no capital. Does the Audit Committee of the FRB New York consider that?

Under the Federal Reserve Act, the stockholders are subject to a capital call at any time requiring them to buy more stock in their FRB. Should such a call be made on the New York stockholders?

The stockholders are also subject under the act to being assessed to offset an FRB’s losses for up to twice their current investment. Are the Audit Committees of the New York stockholder banks aware of that?

What would Benjamin Strong have thought of the finances of the current New York Fed?

From Whom Is the Fed Independent? To Whom Is It Accountable?

Published in The Federalist Society.

The Federal Reserve and its supporters constantly declare that the Fed is and should be “independent.” Whether it is or should be independent of the elected President of the United States is once again a hot issue—as it has been numerous times before in history. Whether the President can fire the Fed Chairman is now a particularly debated question. A more fundamental question is whether any agency of the federal government—including the central bank—can in our constitutional republic be an independent power subject only to itself.

The constitutional bedrock of American government, and of American political philosophy, is that all parts of the government are subject to checks and balances from other parts. This must apply to the Fed as well as to all other government entities. Should one immensely powerful part of the government, the Fed, be exempt from the essential principle of checks and balances? The answer is no. But we have to specify from whom the Fed is independent and to whom it is accountable.

My conclusion is that the Fed is and should be independent of the President, but that the Fed is and should be accountable to (thus not independent of) the Congress.

Congress and the Fed

The Congress is without question the possessor of the Constitutional Money Power: “To coin money [and] regulate the value thereof.” The Congress also possesses the Taxing Power: “To lay and collect taxes.” The Fed is a critical part of both and thus is subject to Congress. We must include taxation because the inflation the Fed creates is in fact a tax; it takes the people’s purchasing power and transfers it to the government.

In addition, the Fed is now running massive losses. As April 2025 ends, the Fed’s accumulated operating losses have reached the astonishing amount of $227 billion. Besides far exceeding the Fed’s capital and rendering it technically insolvent, these losses are a growing hit to the taxpayers. They increase the federal deficit and increase the national debt—both key congressional responsibilities. The Fed has on top of this a more than $1 trillion market value loss on its investments. Imposing these losses and this risk on the government’s finances should by itself sink any claim that the Fed should be completely independent, especially when the Fed has manipulated its accounting in embarrassingly dubious fashion to hide its resulting negative capital.

Further, we must consider that the Fed’s monetary policy is in essence an attempt at central planning and price fixing, using changing and debatable theories and data reflecting the past, with inevitable political effects. There is no data on the future. Neither the Fed nor anybody else has the knowledge of the future which would be required to “manage the economy.” The Fed’s efforts—no matter how much intelligence, data from the past, and good intentions are applied—share with all tries at government central planning the impossibility of the requisite knowledge, as demonstrated by Ludwig von Mises and Friedrich Hayek.

As one notable example, the Fed could not know what the results would be of its unprecedented monetizing of $8 trillion in long-term Treasury debt and 30-year fixed-rate mortgages. As it turned out, this included stoking a new house price bubble. This bloating of its balance sheet by “quantitative easing” was accurately described by former Fed Chairman Ben Bernanke as “a gamble.”

The Fed does not and cannot know what the results of such gambles will be; it is flying by the seat of its pants.

Likewise, neither the Fed nor anybody else can know—but can only guess about—what the celebrated “neutral rate of interest” is or will be. That this theoretical neutral rate is called “r-star” gave rise to this brilliant and honest aphorism of Fed Chairman Jerome Powell: “We are navigating by the stars under cloudy skies.”

While flying by the seat of your pants, gambling with trillions of taxpayer dollars, and navigating by the stars under cloudy skies, how can you claim you should be independent? In my view, you can’t. Accountability to the Congress is required.

Turning to political philosophy, we should recall the conclusions of the congressional study, The Federal Reserve After Fifty Years, published in 1964 under the leadership of Wright Patman, then Chairman of the House Committee on Banking and Currency:

“An independent central bank is essentially undemocratic.”

“Americans have been against ideas and institutions which smack of government by philosopher kings.”

“To the extent that the [Federal Reserve] Board operates autonomously, it would seem to run counter to another principle of our constitutional order—that of the accountability of power.”

These conclusions seem to me correct.

The President and the Fed

It is natural that the President and his Treasury Department should want to control the Fed, since that would give them the power to keep spending money when they are in deficit, by having the Fed print it up and lend it to the Treasury. Presidents of both parties have often wanted lower, or at least not higher, interest rates for political purposes, including financing wars and winning elections, and they have used their influence with the Fed accordingly.

The Treasury Department of course likes lower interest rates on government securities, which reduce the cost of the debt it issues and reduce the amount of new borrowing needed to pay the interest on the old debt. To make the executive the boss of the Fed is to make the borrower the boss of the lender.

Nonetheless, for extended times in Federal Reserve history, especially during major wars and economic emergencies, the Fed has been subservient to the Treasury Department. This began when the Fed was three years old with the American entry into the First World War in 1917. During these times, the Fed devoted itself loyally to financing the government’s deficits as needed. It did so most recently during the Covid-19 economic crisis of 2020-21. Will the Fed repeat this performance in the future? Given a war or emergency big enough, it will.

Historically, under master politician Franklin Roosevelt, “The Treasury controlled most decisions,” and the Federal Reserve “was in the backseat,” according to Allan Meltzer’s magisterial A History of the Federal Reserve. Also during this period, the Treasury took every ounce of the Fed’s gold and never gave any back.

The intense dispute between President Truman and his Treasury Department, on one side, and the Fed, on the other, resulted in the President telling Thomas McCabe, the Fed Chairman, that the Fed was doing “exactly what Mr. Stalin wants.” He then criticized and induced McCabe to resign (bitterly) and chose a new Fed Chairman, William McChesney Martin, who he thought would be loyal. But Martin did not do what Truman wanted; Truman called him to his face a “traitor.” Martin stayed on as Fed Chairman for 19 years.

President Lyndon Johnson had a memorable dispute with the Fed. “How can I run the country and the government if . . . Bill Martin is going to run his own economy?” the furious President demanded. Martin traveled to Johnson’s Texas ranch to discuss the issue, where it is said that Johnson physically pushed the proper Martin around the living room, shouting at him. Quite a scene to picture.

We come to the interesting discussions between President Nixon and Fed Chairman Arthur Burns. Meltzer writes, “Ample evidence . . . supports the claim that President Nixon urged Burns to follow a very expansive policy and that Burns agreed to do it.” Wittily and cynically, Nixon said he hoped that the independent Fed Chairman would independently decide to agree with the President. Burns is said to have remarked with fine irony, “We dare not exercise our independence for fear of losing it.”

The Fed is always in a web of presidential and financial politics. President Trump’s pressure on Fed Chairman Jerome Powell, however extreme the language, repeats an historical tension.

In Sum

We can safely predict that this natural tension between the President and the Fed will continue as far as we can imagine. It reflects the fact that the Fed is constitutionally accountable to the Congress, not to the President.

The Fed remains at all times a creature of Congress—if Congress exerts its authority. If Congress has the will, it can instruct, redirect, restructure, or even abolish the Fed. In addition, as the then-President of the New York Fed testified at Wright Patman’s hearings, “Obviously the Congress that set us up has the authority to review our actions at any time they want to, and in any way they want to.” Should Congress audit the Fed? Of course—and on an ongoing basis.

Moreover, I believe that each of the congressional banking committees should have a subcommittee devoted exclusively to the Federal Reserve and central banking issues.

Discussions of Fed independence often focus on the need to prevent the executive from overrunning the central bank. But American citizens consistent with our Constitution should demand that such a powerful government agency be accountable to the people’s representatives in Congress.

BPInsights: April 19, 2025

Published in the Bank Policy Institute.

The panel also featured Yale Professor Gary Gorton and Mises Institute Senior Fellow Alex Pollock, who critiqued the inability of regulators to differentiate between minor risks and systemic threats.

Congress Should Never Have Created Fannie Or The GSEs

Published in Forbes.

As a result, Congress and three consecutive administrations have allowed the GSEs to remain in conservatorship. And as a recent Law and Liberty article by Alex Pollock and Ed Pinto points out, the GSEs remain insolvent.

The Sound of Five Thousand Banks Collapsing

Published by the Civitas Institute.

From 1921 to 1929, 5,711 U.S. banks went broke. That is an average of 635 failures per year, or about 12 per week for a period lasting nine years, all in a decade that elsewhere featured the 1920s boom.

——

Acting as the lender of last resort to banks by making them collateralized loans from its “Discount Window” was a principal reason for the creation of the Federal Reserve in 1913.  It is still a key function, although at present, loans to banks represent only 0.06% of the Fed’s assets.  Nonetheless, it is a capability that has proven very handy in the many financial crises of the Fed’s career so far.  

With the passage of the Federal Reserve Act, many hoped that the new Federal Reserve Banks would make future financial crises impossible. William G. McAdoo, for example, the Secretary of the Treasury at the time—and therefore, under the original act, automatically the Chairman of the Federal Reserve Board—had this excessively optimistic prediction:

The opening of [the Fed] marks a new era…[It] will give such stability to the banking business that the extreme fluctuations in interest rates and available credits which have characterized banking in the past will be destroyed permanently.

Only one decade later, the still young Fed was facing the failure of thousands of banks, principally smaller banks across the country's agricultural regions. To be specific, from 1921 to 1929, 5,711 U.S. banks went broke. That is an average of 635 failures per year, or about 12 per week for a period lasting nine years, all in a decade that elsewhere featured the 1920s boom.

This now almost entirely forgotten banking bust, and the Federal Reserve Banks’ widespread use of the Discount Window during it, are instructively recounted and analyzed by Mark Carlson in his new book, The Young Fed—The Banking Crises of the 1920s and the Making of a Lender of Last Resort. The book reviews both colorful specific cases and the fundamental ideas involved. Calson makes it clear that the Federal Reserve Banks and Board officers were well aware of and thought carefully about the tensions and trade-offs inherent in their lender of last resort activities.

These include the systemic problem of having many banks in trouble at the same time, the problems of the moral hazard induced by central bank lending, distinguishing illiquidity from insolvency in the time pressure and uncertainty of a crisis, a banker’s first loyalty to depositors vs. the central bank’s shifting losses to depositors, and the central bank itself taking credit risk.

Thus, the book is both an interesting history and an exploration of some core concepts in banking and central banking.

Hundreds or Thousands of Banks in Trouble at the Same Time

As Carlson writes, “the disruptive effects of bank failures are particularly relevant when many banks are in trouble at the same time.” At that point, “the sudden liquidation of all assets of the troubled financial institutions would be disastrous.” Yes, all the troubled banks cannot sell their assets simultaneously when their lenders and depositors want their money back.  

An old Washington friend of mine once asked, “If a good pilot can in an emergency land a jet plane in the Hudson River like Captain Sullenberger did, why can’t we handle financial crises better?” I replied, “To get the analogy right, you would have to picture landing a hundred crippled jets in the Hudson River together.”

“In the 1920s,” says Carlson, “the troubles in the banking system were also widespread… Congress leaned heavily on the Federal Reserve to support the banks.” The book suggests that the new Federal Reserve did well under the 1920s circumstances. The Fed “experienced a large number of successes when providing emergency funds to banks,” Carlson observes, but “other banks failed with discount window loans outstanding, which put the Federal Reserve in uncomfortable situations.”

Why were so many banks in trouble at the same time? The root cause was the First World War, as war was often the key factor in big financial events. As Carlson explains, the “Great War” created a huge agricultural boom in the U.S., and the boom set up the bust. Because of the war, “prices of agricultural commodities soared globally. U.S. farmers bought more land, planted more crops, and raised more livestock amid expectations that the boom would last.... A significant proportion of the expansion was financed through borrowing. … The price of farmland rose notably. … To purchase the increasingly expensive land…farmers needed to borrow.” Whether they needed to or not, many did. So did land speculators.

Then: “the collapse was as dramatic as the run-up had been. … Foreclosures [and bank failures] surged.” Across vast swaths of the country, an agricultural banking crisis descended.  

Moral Hazard

In the 1920s, the Fed was fully aware that being ready to support troubled banks could induce more banking risk—the problem of “moral hazard.” This is the well-known general risk management problem in which saving people whenever they get in trouble makes them more prone to risky behavior.  

Carlson writes, “The greater availability of the discount window…meant that managers and shareholders had more incentives to take liquidity risks.” He quotes the Federal Reserve Bank of Dallas in 1927: “Those extensions of credit simply serve to create further opportunities to make the same mistakes of judgement and to further prosecute the same unsound policies.”  

The moral hazard dilemma of central banking, apparent 100 years ago and, indeed,100 years before that, will always be with us.

Distinguishing Illiquidity from Insolvency in the Pressure of the Crisis

In theory, lenders of last resort should address the problem of illiquidity, where the troubled bank is short of cash but the real value of its assets still exceeds the claims of its depositors and lenders. Thus, in theory, central banks should lend only to solvent borrowers. But to paraphrase Yogi Berra, in theory, illiquidity is different from insolvency, but in practice it often isn’t.  

In Carlson’s more scholarly language:

A lender of last resort will often find it difficult to fully determine the extent to which the need for support is the result of insolvency versus illiquidity. …The experiences of the Federal Reserve in the 1920s highlight that in some cases it will be impossible to determine whether a bank is solvent at the time it requests funds.

In short, the lender of last resort suffered in the 1920s, and in crises, it will always suffer a “fog of financial crisis”—just like generals in Carl von Clausewitz’s celebrated “fog of war.” It is inevitably very difficult to know what is really going on and how big the losses will be.

The Banker’s First Loyalty vs. Shifting Losses to Depositors

The 1920s Fed was clear about classic banking ethics. Carlson quotes the Federal Reserve Bank of Chicago as “firmly of the opinion that the prime obligations of any bank are—first, to its depositors; second, to the stockholders; and third, to its borrowers.”  Does the current Fed say anything that clear?

The Federal Reserve Bank of San Francisco agreed: “A bank’s first obligation is to its depositors. No course should be followed which jeopardizes a bank’s ability to pay its depositors according to the agreed terms.  A bank’s second obligation is to its shareholders, to those who have placed their investment funds in charge of the directors and officers”; the borrowers were an also-ran.

Yet the Fed of the time knew that by acting as lender of last resort, which meant (and means today) taking all the best assets of the troubled bank as collateral to protect itself, the central bank was pushing losses to the remaining depositors. “Reserve Banks officials were aware,” Carlson writes, “that lending to support a troubled bank could end up allowing some depositors to withdraw funds while leaving the remaining depositors in a worse position.” I would change that “could end up” to “ends up.”

Carlson continues, “The depositors that did not withdraw would only be repaid from the poorer assets of the bank; that would likely mean that their losses would be worse than if the Federal Reserve had not provided a loan.”  

The Federal Reserve Bank of San Francisco wrote in the 1920s that discount window lending should not “invade the rights of depositors by inequitable preferences to Federal Reserve Banks.” But it inevitably does.

With the advent of national deposit insurance in the 1930s, depositors as claimants on the failed bank’s assets were largely replaced by the Federal Deposit Insurance Corporation. The problem then became the Fed’s shifting losses to the FDIC. This was an important debate at the time of the FDIC Improvement Act of 1991, and it remains an unavoidable dilemma if the Fed can take the best available collateral at any time.

Credit Risk for the Fed

Today, the Fed tries to avoid taking any credit risk. It now gets the U.S. Treasury to take the credit risk as junior to it in various clever designs, like the “variable interest entities” formed for the 2008 bailouts. But we learn from the book that the Federal Reserve Banks actually suffered some credit losses on their Discount Window lending in the 1920s. That meant the borrowing commercial banks failed, and then the Fed’s collateral was insufficient to repay the borrowing. The combined Fed had credit losses of $1.1 million, $1.3 million, and $1.4 million in 1923, 1924, and 1925, respectively.

One hundred years later, in the 2020s, the Fed has zero credit losses but massive losses on interest rate risk. The aggregate losses arising from its interest rate mismatch are $225 billion as of March 27, 2025, and it has a hitherto unimaginable mark to market loss of over $1 trillion.  One wonders what the Federal Reserve officers of the 1920s would have thought of that!

I conclude with three vivid images from the book:

Getting Bank Directors’ Attention

Carlson observes that the Federal Reserve Banks in the 1920s sometimes required personal guarantees from the borrowing bank’s board of directors’ members for Discount Window loans.  When I related this to a friend, who is a successful bank’s Chairman of the Board, he replied, “That would get the directors attention!”  I’m sure it did then and would today.

Mission to Havana

In 1926, there was a bank panic in Cuba involving American banks there, and more paper currency was needed to meet withdrawals. Carlson tells us that the Federal Reserve Bank of Atlanta “scrambled to assemble the cash and ship it to Cuba. … Atlanta assembled a special three-car train with right-of-way privileges to rapidly make the journey from Atlanta through Florida all the way to Key West.  The train left from Atlanta late Saturday afternoon bearing the currency [and] Atlanta staff and guards.  [In] Key West, the money was transferred to the gunboat Cuba…. The gunboat reached Havana harbor at 2:00 a.m. on Monday, whereupon a military guard escorted the currency…[allowing] delivery to the banks before their 9:00 a.m. opening. …and the panic subsided. … Federal Reserve officials received significant praise from the Cuban government.”

The Fed as cattle rancher

“In addition to the losses,” Calson writes, “dealing with the collateral could sometimes cause considerable headaches.” The Federal Reserve Bank of Dallas “ended up owning a substantial amount of cattle after defaults by both banks and ranchers. … Efforts to sell them had a meaningful impact on the local market prices… there were a number of complaints from the local cattlemen’s associations.”  A 1925 memo from Dallas described the “challenges of managing several hundred head of cattle acquired from failing banks in New Mexico.”  This seems a good parting vision for Carlson’s insightful study of the early Federal Reserve wrestling with a systemic agricultural banking crisis.

Overall, The Young Fed is a book well worth reading for students of banking, central banking, and the evolution of financial ideas and institutions.

The Federal Reserve’s Accounting for Its Own Losses Is Emerging as an Embarrassment That Only Congress Can Fix

Published in The New York Sun.

America’s central bank fails to account for its own red ink the way it requires of the banks it regulates.

A basic principle of accounting is that net operating losses are subtracted from retained earnings and thus from capital. If the losses are big enough, capital goes negative, your liabilities exceed your assets, and you are technically insolvent. The Federal Reserve requires all the banks it regulates to follow this principle.

Remarkably, though, the Federal Reserve proclaims itself exempted from this basic — and obvious — arithmetic. Exempted by whom? By itself. This is an embarrassment. It is also a conflict of interest and a temptation for a money-losing entity to have control of its own accounting rules.

The losses of the Federal Reserve since they started in 2022 are so big — $226 billion so far — that they have wiped out all the central bank’s retained earnings, which it calls “surplus,” and all its paid-in capital, five times over. Here is what the simple arithmetic adds up to:

The Federal Reserve’s accumulated losses are $226 billion. Retained earnings (“surplus”) are 7 billion. Subtract that to get retained earnings of negative $219 billion. Subtract paid in capital of $37 billion. That leaves actual capital of negative $182 billion. It’s simple and straightforward.

It means that the United States Federal Reserve has lost all its retained earnings and all the capital that its stockholders — private commercial banks — invested in it, and then lost $182 billion more. Nonetheless, the Fed publishes a balance sheet that shows positive capital of $44 billion.

How can that be? Well, it’s a great thing, if you are losing an ocean of money, to set your own accounting rules so you can avoid the effect of the losses on your capital. To do that, the Federal Reserve books its losses as an asset. It manages to keep a straight face with central banking dignity while it explains that its losses are a so-called “deferred asset.”

Most newspapers dutifully repeat this, but anyone who passed Accounting 101 knows that it’s nonsense. In accounting terms, the losses are a $226 billion debit which should go to reduce retained earnings, but instead is hiding out in a more than dubious asset account.

You may wonder how this can happen when the Fed’s balance sheet is audited by an independent accountant (currently KPMG). As the auditors make clear every year, they do not examine the Fed’s books according to Generally Accepted Accounting Principles, but instead follow rules devised by the Fed.

To our particular point, they follow the “deferred asset” rule the Fed made up for itself in 2011 when it realized it might have unprecedented losses and wished to obscure their effect. It has turned out that the losses and the obscuring are far greater than the Federal Reserve expected and continue to get bigger every month.

Fed representatives argue that negative net worth in a paper money-printing central bank doesn’t matter and that no one will care if the Fed is technically insolvent. They may be right, even though the Fed’s losses are borne by America’s taxpayers and increase the government’s budget deficit and the national debt.

If, in any event, the Fed is convinced that no one cares, why would it bother to hide the true capital and call into question its accounting probity? If you are the greatest central bank in the world, the least you can do is keep accurate books. The Fed should report the true capital number.

The Congress has oversight authority and responsibility for all aspects of the Federal Reserve, including its accounting. I believe Congress should investigate the Fed’s accounting and then direct the Fed in legislation how it wishes the books to be kept. The governments of other countries certainly do this.

The governing statute of the Swiss National Bank, its central bank, requires the SNB to mark its investments to market and reflect the results in its profit and loss statement and its capital. If the Fed had been required to do this, its reported capital at year end 2024 would have been negative $1.2 trillion.

The Bank of Canada is required by the Bank of Canada Act to follow generally accepted accounting principles, which in Canada means International Financial Reporting Standards. As these are applied, the Bank of Canada has been reporting that it has negative net worth — as it does.

Congress could fix the Fed’s wayward accounting by instructing the Federal Accounting Standards Advisory Board, which issues official accounting standards for government entities, to develop accounting standards for the Federal Reserve.

It could also authorize the Government Accountability Office, the government’s chief auditor, to audit the books of the Fed in accordance with such standards. No government entity, especially one with losses counted in hundreds of billions of dollars, should be writing its own accounting rules.

Not Another Free Lunch

Published in Law & Liberty with Edward J. Pinto.

Don’t let Fannie and Freddie turn back into GSEs.

Once again, we have efforts to release Fannie Mae and Freddie Mac from the conservatorship of the Federal Housing Finance Agency in which they have been confined for nearly 17 years—ever since the US Treasury did a 100 percent bailout of their creditors in 2008. Pros and cons are hotly debated relative to the proposed release of the twins that continue to rank among the largest systemically important financial institutions in the world.

The ongoing conservatorship means that the government has total control over these huge government-backed mortgage enterprises, with $7.7 trillion in combined assets. Since the bailout, the government has also been by far the biggest equity investor in them. Although they are often still called “GSEs” (“Government-Sponsored Enterprises”), in fact, while they are in conservatorship, they are not GSEs, but something very different: Government-Owned and Government-Controlled Enterprises. The proposed “release” transaction would give private shareholders control instead. Unfortunately, this could turn Fannie and Freddie back into GSEs, which would be a grievous mistake.

The US Treasury owns all the senior preferred stock of Fannie and Freddie; this stock has a combined liquidation preference of $341 billion as of December 31, 2024. This is more than twice their combined total book equity. In other words, not counting the government’s investment, Fannie and Freddie are deeply insolvent, and have been since 2008.

In addition, the Treasury owns warrants that give it the right to acquire new stock so that it owns up to 79.9 percent of Fannie and Freddie’s common stock for a minuscule exercise price. (The specific exercise price of the warrants is one-thousandth of one cent per share.) Exercising these warrants could give the Treasury a large profit, but they expire in September 2028, during the term of the current Trump administration. This gives the Treasury a duty to realize their value before they expire. Treasury could sell the warrants, exercise them, and then sell the stock, or exercise them and simply hold the stock along with the senior preferred stock.

To retire the government’s preferred and common equity stake would require a refinancing of massive scale, or a taxpayer gift from the US Treasury of tens of billions of dollars to Fannie and Freddie, or both.

The conventional narrative is that an exit from conservatorship would be a “privatization” and Fannie and Freddie would again become “private” companies. It is not the case. To be a GSE means that you have private shareholders, but you also have a free government guarantee of your obligations. As long as Fannie and Freddie have that free government guarantee, they will not be private companies, even if private shareholders own them.

As GSEs before 2008, the companies always enjoyed such a hugely valuable but free government guarantee. Because they did, no private company could successfully compete with them, and they were never private companies themselves. As our colleague Peter Wallison explained in his book, Hidden in Plain Sight, they were an unhealthy mix of socialized government risk and private profit.

The Essence of a GSE

Former Democratic Congressman J. J. Pickle of Texas pointedly summarized the GSEs: “The risk is 99% public and the profit is 100% private.” It was always said that the government guarantee of the GSEs was only “implicit,” but it was and is nonetheless fully and unquestionably real. This was definitively demonstrated by the Treasury’s $190 billion bailout of Fannie and Freddie in 2008, and the simultaneous creation of explicit government credit commitments during conservatorship. The bailout completely protected all of Fannie and Freddie’s creditors, even egregiously including the investors in their theoretically risk-absorbing subordinated debt. Creditors of GSEs are always saved by the government, and everybody knows it. The global sales of their securities and the credibility of the sponsoring government depend on it. To paraphrase the memorable words of a MasterCard commercial, what is the value of a free, unconditional, irrevocable, ever-greening line of credit from a sovereign creditor to an insolvent debtor? “Priceless,” the commercial said, but we calculate in the last section below the significant price that Fannie and Freddie should have to pay.

J. J. Pickle’s insight again fully applies to the new Fannie and Freddie “release” proposals and the ongoing debates of 2025. It displays the financial essence of a GSE: the immense value of the free government guarantee is a gift to the private shareholders, with little benefit to first-time homebuyers, as research has demonstrated. This obviously bad idea nonetheless has been supported by many politicians in the past. In their perennial search for a free lunch, they should not make the same mistake again.

The current debates must confront the fact that an ongoing government guarantee for Fannie and Freddie is an indispensable part of any “release” transaction. These fundamental questions and answers make that clear:

Question: Is Fannie and Freddie’s business model sustainable without a government guarantee?

Answer: No. Their business, their size in the bond market, their leverage, their access to credit risk-averse global investors, and their claim to lower mortgage interest rates all entirely depend on the government guarantee.

Question: As a practical business matter, can Fannie and Freddie exit conservatorship without the government guarantee?

Answer: No. The government guarantee would be always critical to their credit standing, but even more so immediately after their release from conservatorship.

Question: Could the government get out of its guarantee, even if it wanted to?

Answer: No. The government is locked in because Fannie and Freddie are “To Big to Fail” (TBTF), just like the largest banks. Indeed at $7.7 trillion and growing they are Far Too Big to Fail (FTBTF, we might say). No matter what the government may claim, the market will believe they are in fact guaranteed and the market will be correct.

Since no “release” deal is possible without a government guarantee, we arrive at this essential question:

Should Fannie and Freddie’s government guarantee be a free guarantee?

Answer: No. In line with Pickle’s point, public risk should not be turned into private profit. The government, and hence the taxpayers, should be fully and fairly remunerated for the risk and the cost of their massive guarantee. This will require legislation and Congress must make sure it is part of any “release” transaction.

Therefore, we must determine what the price of the government guarantee should be.

How Much Should a “Released” Fannie and Freddie Pay for Their Government Guarantee?

There are two components of the fee Fannie and Freddie should pay the Treasury for its guarantee. The total fee should be the same whether the guarantee is “implicit” or explicit, because it is equally real in both cases. These components are Risk and Current Cost.

The “Risk Fee” is today’s price for the possibility of having to cover future losses with future bailouts.

The “Current Cost to Treasury Borrowings Fee” is the offset for how much Fannie and Freddie cost the Treasury and the taxpayers by making Treasury notes and bonds more expensive. Higher interest rates for the Treasury on its own debt result from the competition that Fannie and Freddie’s massive $7 trillion in mortgage-backed securities create for investors who want US government credit.

The fee paid by Fannie and Freddie should be the sum of these two.

Considering the Risk Fee, we suggest that a close, relevant analogy is what the largest, TBTF banks have to pay the Federal Deposit Insurance Corporation (FDIC) for the implicit total government guarantee these banks receive. Like Fannie and Freddie, the real guarantee is for all the obligations of the TBTF bank; it is not just for the smaller amount of the formally guaranteed “insured deposits.”

Correspondingly and correctly, these banks are assessed FDIC fees on their total liabilities, not just the insured deposits. Likewise, Fannie and Freddie’s fee should be assessed on their total liabilities, or $7.6 trillion as of year-end 2024.

Unfortunately, we cannot see what the TBTF banks pay the FDIC, because although banks report FDIC premiums on their Call Reports, the FDIC removes them from the published version and keeps the numbers secret. But we can estimate an appropriate Risk Fee by analogy to the FDIC standards.

Fannie and Freddie certainly qualify as large and complex companies. As shown in the FDIC’s table of “Total Base Assessment Rates,” the corresponding “Initial Base Assessment Rate” for “Large & Highly Complex Institutions” is 5 to 32 basis points per year (a basis point is one-hundredth of 1 percent, or 0.01 percent). Multiplying this by $7.6 trillion in liabilities suggests a range for the Risk Fee for the combined Fannie and Freddie of $3.8 billion to $24 billion per year.

Where would Fannie and Freddie fall in the FDIC’s Large and Highly Complex range? Their risk is entirely concentrated in real estate credit, and their capital ratios are very low. Congress should ask the FDIC what it would hypothetically charge Fannie and Freddie to insure their liabilities. Congress might also ask Warren Buffett what price Berkshire Hathaway would charge for providing such insurance.

In the meantime, suppose as a starting point that with their concentrated real estate risk and little capital, Fannie and Freddie were 25 percent of the way from minimum to maximum, or about 12 basis points per year. That would be a Risk Fee of $9 billion per year, or about 25 percent of their combined 2024 pre-tax profits of $36 billion.

We present this estimate as a starting point for further discussion and analysis. But it is certain that the right Risk Fee is not zero.

Without doubt, the presence of trillions of dollars of Fannie and Freddie mortgage-backed securities in the market, competing with the US Treasury’s own debt for purchase by credit-risk averse investors, drives up the cost of Treasury debt and thereby increases the government’s deficits.

How much does this competition cost the Treasury? The answer is: a lot—an estimated 10 to 15 basis points on its $27.7 trillion of marketable debt, or from $29 billion to $43 billion a year. Over ten years, this imposes a $290 billion to $430 billion additional cost on the Treasury, without even compounding interest.

The estimate of the cost to the Treasury is from a February 2025 update by Amanda Dial, Edward Pinto, and Tobias Peter that uses the Federal Reserve’s own estimates of the effect on Treasury debt yields of the Fed’s “QE” (Quantitative Easing) purchases of MBS, adjusting for current outstandings, relative proportions and conditions. The fundamental insight is that if the Fed’s taking MBS out of the market lowers the cost of Treasury’s term debt by a certain amount, putting that many MBS into the market will increase it by the same amount.

Taking the increased Treasury cost of $29 to $43 billion caused by Fannie and Freddie’s government-guaranteed MBS, and dividing this cost by their $7.6 trillion in liabilities suggests that Fannie and Freddie are enjoying a taxpayer subsidy of 38 to 57 basis points a year on their liabilities.

Let us take the middle of that range: 48 basis points. A Current Cost to Treasury Borrowings Fee of 48 basis points would just offset the increased cost Fannie and Freddie impose on the Treasury. That fee assessed on Fannie and Freddie’s $7.6 trillion in liabilities would be $36 billion, or 100 percent of Fannie and Freddie’s pre-tax profits. In short, the subsidy from the Treasury equals the totality of Fannie and Freddie’s profits.

The Total Fee

Adding the two components together gives us the total fee that Fannie and Freddie should pay the Treasury for their government guarantee:

On $7.6 trillion in liabilities, that would be $46 billion or 128 percent of their pretax profit. While others may have their own lower estimates, any legitimate Total Fee would constitute a significant portion of Fannie and Freddie’s pretax profit.* Needless to say, the private shareholders, present or future, would not like this outcome!

All these numbers speak to one truth: the essence of a GSE is to convert a free government guarantee and public risk into private profit. That should not happen again. Fannie and Freddie should pay for their government guarantee at a fair rate. If they can’t do that, they must remain stuck in the government. They should not be allowed to turn back into GSEs. Peter Wallison and Congressman Pickle, you were both so right!

* Supporters of Fannie and Freddie’s privatization would try to give them every benefit of the doubt. So, let’s take the lowest estimate of Current Cost to Treasury Borrowings Fee or 38 basis points and generously divide that in half—call it 19 basis points. In addition, suppose we drop the 12 basis point Risk Fee to 9 basis points, only 15 percent of the way from the minimum to the maximum on the FDIC’s “large and highly complex” range. The result is that, at the very least, Fannie and Freddie should pay 28 basis points or $21 billion per year for their government guarantee, which is still 58 percent of their pretax profit.

No Funding from The Fed for the CFPB

Published in The Wall Street Journal,

Chris Dodd and Barney Frank point out that the Consumer Financial Protection Bureau was brought into being by proper legislative action in 2010 ("Trump Harms Consumers by Weakening the CFPB," op-ed, March 13). They leave out, however, that the act was approved on a mostly party-line vote when the Democratic Party had majorities in both the House and Senate.

Perhaps knowing that their control was fleeting, the drafters attempted to restrict future Congresses from controlling the agency’s finances. They did so by stipulating that the CFPB would be funded out of the combined earnings of the Federal Reserve—at the time a safe bet, considering the central bank had been profitable for nearly 100 years. As long as that remained the case, lawmakers would be deprived of their essential power of appropriation.

But the Fed ceased to have any combined earnings in late 2022, and it has since racked up massive losses. So long as those persist, there are no earnings that can be used to fund the CFPB legally under the terms of the Dodd-Frank Act. When the CFPB now wants to ask for funding, it should have to go to the Congress and ask for appropriations—exactly as it should’ve been in the first place.

Alex J. Pollock
Mises Institute
Lake Forest, Ill.

A 2025 Review of the Governance, Mission, and Independence of the Federal Reserve

Hosted by the Federalist Society.

The Federal Reserve’s governance has captured the attention of Congress, the Administration, and the media. President Trump’s executive order on independent agency accountability specifically requires the Federal Reserve’s supervision and regulation function to coordinate with the White House, while the House Financial Services Committee has constituted a new task force to study the Fed’s monetary policy function, among other things. This legislative and presidential attention to considering Fed reform follows supervisory failures associated with Silicon Valley Bank, concerns around de-banking, and the Fed’s massive losses associated with its last round of quantitative easing. 

This webinar will discuss potential reform to the Fed’s governance as well as the purpose and scope of the Fed’s independence. It will feature a keynote address from Representative Frank Lucas—Chair of the House’s Task Force on Monetary Policy, Treasury Market Resilience, and Economic Prosperity—as well as remarks from panelists Professor Christina Skinner (The Wharton School), Don Kohn (Brookings Institution), and Alex Pollock (Mises Institute). Andrew Olmem (Mayer Brown) will moderate.