The Fed's D-Rate: 4.5% At Dec 31, 2013... And Dropping Fast

Tyler Durden's picture

In April of 2010, Zero Hedge first brought up the topic of the Fed's DV01, or the implicit duration risk borne by the Fed's burgeoning balance sheet which at last check will approach 25% of US GDP by the end of 2013 (tangentially, back in 2010 the Fed's DV01 was $1 billion - it is nearly $3 billion now and rising fast). Recently, we have noticed that the mainstream media has, with its usual 2 year delay, picked up on just this topic of the implicit and explicit risk borne by Bernanke's grand (and final) monetary experiment. And slowly but surely they are coming to the inevitable conclusion (which our readers knew two years ago), that the Fed has no way out? Why? Ray Stone of Stone McCarthy explains so simply, a Nobel prize winning economist can get it.

From Stone McCarthy

Further asset purchases would compromise the Fed's longer run profitability in two ways.


First, because the securities have been purchased during a period of economic distress the yields on these securities are unusually low. The purchase of these securities has been financed by reserve creation. The cost of reserve creation is the interest rate paid on reserves (IOER) currently only 25 bps.


Of course, the interest rates on IOER, RRPs, and Term Deposits all represent variable interest rates, while the yields on SOMA are effectively all fixed rates. Thus, there is an asset/liability mismatch, which could compromise the Fed's Net  Interest Income (NIM) should short term interest rates rise. The Fed's exit from the extraordinarily low funds rate regime will not be compromise by the prospect of reduced or negative NIM. Instead, the remittances to the Treasury would be reduced or suspended.


How high do these short-term interest rates have to go before the NIM become negative?


In 2012 the Fed generated $80.5 bln in interest income on an average $2.606 bln in SOMA holdings, or about 3.1%. The SOMA was funded by paying only 0.25% on average reserve balances of $1.527 trillion or about $3.8 bln. In other words NIM was about $77 bln.


Had the IOER been consistent with what FOMC participants regard as normal in the longer-run, say 4-1/4%, NIM in 2012 would have been only about $15 bln, with a slightly restrictive posture, say 5-1/4% NIM would be close to zero, and with at 5-1/2% NIM would have been negative.


Now if we do the same arithmetic with a SOMA that is increased by $1 trillion due to the asset purchase programs, even keeping the effective yield at 3.1%, we see that NIM turns negative at a lower funds rate. Gross interest income from SOMA would increase to around $115 bln. At the same time if the IOER was set at 4-1/4%, NIM would fall from $15 bln to only $4 bln. At a 4-1/2% NIM becomes negative.

In other words, at Dec. 31, 2013, a 4.5% interest rate (or, as we call it, the D-Rate) is where the Fed starts losing money.

And then, if the Fed waits another year, the NIM breakeven is 3.5%... if the Fed then waits another year, the NIM breakeven drops to a minuscule 2.5%... and so on until year after year, the tiniest rise in rates will force the Fed approach Congress and explain why suddenly, not only is it not remitting interest income to the Treasury, but why just as suddenly, there is now a credit balance, that has to be funded by the Treasury (a move which monetarily will require the Fed to bail itself out, but which politically and economically will be an epic and final hit to the credibility of the Fed, as the Fed will be officially printing money just to print money).

Of course, the above analysis assumes the Fed delays and avoids exiting QE in 2013, and then 2014 (and so on) as this is the last instrument Bernanke and his successor have to push up the stock market, never mind the economy, the unemployment rate or inflation. Which the Fed will have no choice but do, and yet the longer it build the wall of QE worry, the greater the negative sensitivity to even the smallest increase in interest (and IOER) rates, if and when inflation picks up and Bernanke is taken to task with his "15 minutes" promise of eliminating hyperinflation.

In other words, while QE4EVA may be unlimited in the eye of the beholding Chairman, it is very much limited by the amount of reserves pumped into the system, and the amount of cash that Ben will have to pay banks as interest on their excess reserves.

Finally, as once again Zero Hedge readers know well ahead of everyone, it will be the foreign banks that will be the proud recipients of the tens or hundreds of billions of IOER funds when the inevitable IOER rate hike starts. This was explained here:

[S]ince it is improbable that excess reserves held by any banks will decline at all in the coming years, one can also assume that the annualized interest paid to foreign banks, which would amount to at least $5 billion pear year, every year, will continue indefinitely as a direct Fed subsidy to the bottom line of Foreign banks.


All of this, of course, ignores what happens should the Fed hike interest rates across the board, which will also mean rising the rates on IOER, once inflation finally strikes: simple math means a 1% IOER means some $20 billion in interest paid to foreign banks, 2% - $40 billion, 5% - $100 billion paid to foreign banks, and so on. Putting these numbers in perspective, let's recall that Italy's third largest bank just got a €3.9 billion bailout (its third), and has a market cap of some €2.9 billion.

Expect the MSM to figure out that it is precisely the foreign banks operating in the US, which now hold well more than half of all excess reserves in circulation, that will be the majority benefactors of the dollar bonanza that will be unleashed once the IOER begins its trickle up, in the next few years (or months at the rate record gasoline prices are soaring). Sadly, by then will we have far greater problems as a result of nobody once again understanding what is really going on behind the scenes.

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John Law Lives's picture

"...but which politically and economically will be an epic and final hit to the credibility of the Fed, as the Fed will be officially printing money just to print money)."

The DHS plans to stand ready with a massive cache of ammo...


VonManstein's picture

Europe looting the US. All planned.

You are the laughing stock of the world with a president like that. European finance has a sophisticated approach to the theft of the colonies wealth

JuicedGamma's picture

I wondered why they were all so giddy and gushing on the continent back in 2008 when he was elected.

falak pema's picture

shades of crimean campaign in WW2, operation barbarossa! By your avatar! 

magne13's picture

The FED has essentially become the Zombie Bank.  the more bad assets the FED buys the less bad assets the Banks have to write down and take "actual" losses.  The FED can print money, hold assets and run down a bad portfolio of worthless MBS and other assets a lot easier than any other entity.  This combo of buying assets with virtually free interest money (printed) allows the FED the ability to take in some income from an asset over a longer period of time without the hassle of reporting negative earnings from that asset, like a traditional bank would.  The FED does the same thing with US treasuries, basically it acts as a conduit for the Treasury as they are merely one and the same, which is the ultimate gig if you ask me, I need more money (treasury), ok Ill print it for you (FED) and when nobody else wants your bonds, ill buy them all and give you back the money, the greatest circle jerk of them all.  Downside? Destruction of trust in the system, stagnation in organic growth, higher living costs, higher structurally dependency on the government, i.e. SOCIALISM and when all else fails Communism.  Next step take away the peoples access to weapons, before they realize what we are doing.  If things get ugly fast then create some sort of event "diversion".  Rinse, Repeat, Recycle and before you know it 20 years go by.  So who cares its only time.  The FED is in the business of buying time, yet they aren't really buying it, they are stealing it, we are all to busy to notice.

spinone's picture

The FED is the bad bank.  They will just let it go bankrupt and start a new bank with the same owners.  This is the 3rd central bank of the US.  We'll see a fourth in our lifetime.

andrewp111's picture

Or Congress will just bail it out with trillion dollar coins.

michael_engineer's picture

I believe you are describing the concept of "doing God's work". From the overarching view, that may be how it's been considered. I suspect there was some high level meeting at the top of the banker and WFed food chain where that terminology was actually floated out as a justifying rationale. And that's why it was parroted by Lloyd Blankfein. Lloyd, am I right? You can let me know by giving me an up arrow for being right, and down for not.

bad craziness's picture

And so what happens when you revalue the gold at the central banks to reflect this debacle. Why does not zerohedge link / acknowledge Jim Sinclair and the only viable solution?

Never One Roach's picture

Moar Bank Bonuses is all that matters. Everything else is trivial. Propping up the stockmarket, housing market, etc with VooDoo tactis will eventually lose out to Market Forces.  You cannot fool Mother Nature.

sbenard's picture

The Day of Reckoning approaches! Calamity is certainty! Plan and prepare accordingly!

Downtoolong's picture

The biggest greater fool of all greater fools will be the one who takes over the job from Benny B. and ends up inheriting the blame for it all.


riphowardkatz's picture

the fed chair is number 96 on the blame list with the average blame cycle now at 3 months it will be a  long time before the fed chair will be blamed.

michael_engineer's picture

"it is precisely the foreign banks operating in the US, which now hold well more than half of all excess reserves in circulation, that will be the majority benefactors of the dollar bonanza that will be unleashed once the IOER begins its trickle up, "

Ever since the concept of "trickle down" economics was floated some years back, I have contended that it was really "cover" for trickling up and trickling out of the country to put foreign workers to work over higher cost American workers. After many years of that, we have a hollowed out middle class, failing infrastructure, and a very top heavy 0.1 percent. Notice the word "trick" is embedded in trickle. What a laugh that must have been for some who understood what the overarching affects would probably be.

It is interesting that this article considers the trickle up concept.

TK69's picture

I'm sorry but if the fed isn't audited and it has the ability to create money out of thin air, then what makes you think it won't do it.  What makes you think any of this is even relevent.  Truth be know is that they don't even set interest rates as so many people seem to think.  The market does.  The rates are low because banks are not lending which is the point of the fed created free interest to banks. The fed does not want banks to lend.  If it did, it could set negative interest rates on banking reserves. Thus, the problem is that people are not borrowing enough money to support the economy, not bank balances sheets. 

And truth be know, all one really need to do is to set banking reserves at 100% or more and this will control inflation.  The biggest danger is the government who would love for an excuse to confiscate the reserves and spend the money themselves, which still won't don much.  The foreign markets are also rigged which is the purpose of fiat money. And without people buying exports, currency manipulation means nothing but more deflation.

What is coming down the pike is mass deflation, not inflation, except for things that are effected by fed easing like stock markets, financial products, government balance sheets and things that are needed like food. As less things are created and sold, there are less things to spend money on and those things that are still in demand get more expensive.  The soviet union did not die a death of mass inflation, but died from mass deflation as less and less people created things that others wanted to buy.

If it were not for computers, there would already be a collapse of the division of labor.  But computers are making this impossible for governments to regulate trade which is better for consumers and are so far, saving nations.  Bit without inflation, which allows for higher tax revenues, most governments would find themselves irrelevant and obsolete.  Fiat money is design to keep money and thus control within borders.  Without it, you would not have stagnet nations.

Wealth will continue to concentrate while the massess get poorer and poorer until those who pay the bill out number those who vote.  And at some point the yonger generation will refuse to pay for the older; ie grandma. 

The problem is political.  As long as people want to plunder their neighbor to pay for their benefits, nothing will change and they will get poorer. Without infaltion, there is no way to pay for this. 

What happens when you run out of others peoples money?  If you can, you print more of it for you and your firends.

riphowardkatz's picture

ok I got it. Less things and more money will lead to deflation. Make perfect sense.


TK69's picture

How do you think money comes into circulation?  How does it leave the banking reserves? 

riphowardkatz's picture

how? a bank lends against its reserves. its ability to lend is dictated ,at least in theory, by how much money it has in its reserves. more reserves, more lending, more reserves more money to borrow and buy oil, gold, silver, food futures etc. that is how. less stuff and more money to buy it causes a rise in prices. 

another way it comesinto circulation is through the fed buying 85 billion a MONTH. You think the government is sitting on that for a rainy day? Or are they beefing up military, infrastructure spending, food stamps and competing for the resources required?

could prices fall for sometime like today? sure but the cause is not money supply or reserves therefore it is not deflation.

have you sold everything you have to get more of those precious and oh so scarce dollars?  Are you looking forward to buying that house with $100.00 and some oil for $10?



TK69's picture

And yet the point eludes you.  In order for their to be a loan, someone must borrow it.  But how many people in mass can do this?  And the money lent must be paid back going into banking reserves. And this means less money spent in the economy.  Of courser banks can use these reserves to buy things like stocks and commodities but as people pay off debt and it is not replaced and expanded (in order to overcome diminishing returns), then more people have even less money to spend; hence lay offs.

And again when the fed buys treasuries, the proceeds go into banking reserves, which is used to make more loans.  Of course, the treasury has been forcing the primary to buy it's IOU's, then the fed buys this from the banks thus ensuring that the government gets funded. The primary inflation creator is the fractional reserve.

The money supply does not decrease. It is sitting in bank reserves.  It can only decrease upon default, after all it is noting but a book entry (digital credit) with in a closed loop of banks. 

If people do not have the money to purchase things, prices fall except for those things that people do have the money to buy like food and Oil.  As various distribution centers get shut down, prices do rise.  Afterall makets are great price deflators, but this is not the same as monetary inflation.

riphowardkatz's picture

Unfortunately your argument is not backed up by any facts whatsoever....

total outstanding consumer credit 2008= 2,548.8
total outstanding consumer credit 2012=2,778.2 billions...

federal debt 2008 10,024,724,896,912.49
federal debt 2012 16,066,241,407,385.89

does not include state and city debt
does not include unfunded liabilities

and true money supply

This is not the soviet union, this is unlike anything ever done before. Deflation is simply not an option for central banks. The redemptions and unwind would never be accepted by politicians or their constituents. 

Housing in major markets has recovered to near 2008 levels. Gas is up. Food is up. Gold is up,. Silver is up. 
and the fire which is just beginning has a guy standing by with a big tank of gas(85 billion a month) that he is ready to douse it with. 

TK69's picture


And yet again, you make my point.  You just need to think through with what you are saying.  THe extension of credit is what expands the money supply. Money lent must be paid back even if it from student loan debt.  ANd btw, student loans only help to inflate certain segments like education.  You need to ask yourself how many people can or will afford to take on more borrowing.  Some will, but the question is how many which is not reflected in your numbers.  ANd whether this is enough to support the current economy.  At some point it is.

And you should to take a look at the velocity of money, which has been decreasing.  Why is it decreasing?  Because less and less people are able to borrow money.  SUre you may have a smaller amount of people borrowing more money but what is happening with the masses is the key.  It is liken to a farm where by only certain crops get watered, instead of the whole farm.

When you inflate the money supply in order to build things like roads, bridges, and tall buildings, that over wise would not exist prior (of course private companies could do this at a fraction of cost (deflation)), there is no way to support such things in the long run without more inflation.  Of course you can cut government restrictions and this would grow the economy by leaps and bounds.  THe problem is really government restrictions,taxes, and legal tender laws.

Because of diminishing returns, all cost rise in the long run as things wear.  So, the money supply must not only be keep the same to cover it's currentant existence but must be inflated in order to overcome additional cost unless people are allowed to innovate and create which reduces cost;ie get rid of government regulations, premits, and fees.

In the past people have always borrowed more money, until recently.  Government of all sizes have grown because of this and created a lot of restrictions.  Inflations helps to avoid those restrictions without reducing the economy.  But this is only temperaly.

But as some point the masses are saturated, which has never been the case before.  Today, almost everything is leveraged.  This is how big companies get so big, otherwise pop and pop stores would rule as it is easier to run and has less corporate and government bureaucracy to deal with.

At some point you will have mass inflation, althoug not hyperinflation.  However, for this to occur the governmetn must be reduced signifigantly which most likly will not happen.  ANd if it is not reduced people will get poorer and poorer and less and less money circulates throught the economy.  At some pont the governmetns checks will have to bounce.


riphowardkatz's picture

holy smokes.  Repeat after me. more money less stuff equals higher prices. what cant you understand about that?

you just make stuff up
"In the past people have always borrowed more money, until recently"

I just showed you that consumer credit is increasing.

And the ignorance of claiming that student loan debt OR gov debt or any debt only inflates education prices or the prices of the area the money goes to is just ignorant. Do the professors or schools never see the money? do they now buy stuff with it ? do they not build houses, buy commodities, cars? or once it goes to the school POOF its gone.


Oh what do you know I forgot to mention corportae debt
Record-setting year for corporate debt

you keep collecting those dollars which will gain much more value in your estimation. I will buy real stuff and we can let reality be the judge.


TK69's picture

You are confusing monetary inflation with price increases. They are not the same.

Think of it as this way. If people are buying less goods and services (lack of demand) because they don't have any  money,  then this means that less goods and services are sold,  which means lower wages, profits, and things like taxes; hence deflation.  If people are spending more money than there would be more goods and services sold which means more jobs and higher wages and  more taxes paid with profits.  The question is where does the money originate and how much is entering circulation.  This is where your confusion is.  Physics, economics, and math are what they are.

But yet the question remains.  If there is all kinds of inflation, where is it?  From imports?  From oil?  From other commodities?  More money and more growth, right?  Do you count currency manipulation from foreign governments as inflation creating artificial demand?  This is not the same as monetary inflation.  After all foreign money only changes ownership of existing money in circulation; ie not money that hasn't been created. 

If we have monetary inflation, then why is not the economy growing? It is to some extend thanks to bank bailouts, and rising markets (inflation).  But what about the over all economy?

 Why are many businesses closing down and even less being created, which is a form of deflation.  And Why are not more people spending more money thus inflating the economy.  Why is it not growing? There is a reason.  The fed is pursuing the so called wealth effect for a reason which it would not have to do if the economy was being inflated.

And btw, How can you claim not have inflation when you throw money at a economic sector but yet claim to have it in the economy with banks lending so much money? It is contradictory.  It seems to me that you have some studying to do.

As people borrow and spend money on existing goods and services, the money filters through the economy.  But with more and more people paying off debt, money that was originally lent goes right back into backing reserves.  It is not being relent.  But cost are still rising (diminishing returns).  Less money to pay for higher cost is a form of deflation.

Ask yourself why else are banking reserves so high if so much money is being lent into circulation? Why is the fed buying government bounds if there is so much money available. 

 If the fed wanted too it could set negative interest rates on these reserves forcing the banks to lend.  But the fed does not want them to lend.  For if they did you would have massive inflation.

For a very long time the illusion of prosperity was created using lose loand standards and money created out of thin air. But money lent (causing a boom) must be repaid back (causing a bust).  And when it gets paid back it goes into banking reserves to be lent again.


riphowardkatz's picture

I am perfectly clear on the definition of inflation and deflation. A rise in a price caused by an increase in money supply. That is exactly what is happening. That is why housing recovered, that is why gold is up 50%, silver 100%, food 100%, lumber 100%, drug costs 50%, education 30% rent 50%

I just showed you that there is record lending and you keep saying money is being paid back. Based on what? Provide one fact that shows that? Where is debt decreasing? Please point to one fact to show it? PLEASE I would love to see it. 

you cannot because
record borrowing by corporations
record borrowing by individuals
record borrowing by governments

The fed doesnt want money being lent, that is funny stuff, then Why are they buying 85 billion of debt a month? why are they makng the banks whole through buying the supposed debt that MUST be paid back? why are they pushing down yields? why are they encouraging congress to ease lending standards? 

Why are reserves so high? because they are terrified of redemptions, they are afraid of deflation but that fear is the exact reason it will not happen.

I am done arguing with you. I have heard deflationists like you bellow about it for the past 5 years in the face of every fact you just keep on ignoring. Again hang on to those dollars because you are about to get a lot wealthier. 

Keynes was right not 1 in a million can see or understand inflation.  

TK69's picture

First of all, a rise in price is caused by an increase of demand.  Whether the increase of demand was do to monetary inflation is another matter.  Prices rise and fall forvarious reasons. For example China prints it's own money to buy our money.  Then the Chinese beneficiaries may buy more food, which causes food prices to rise in terms of us dollars. To the American consumer they see price inflation. But this inflation would caused by more demand from Chinese consumers, not inflation from in the money supply.  The chines would use existing American dollars to buy food from US farmers, which is only an adjustment in the balance of trade not the overall money supply.

And btw, the housing market has not come back as banks are holding onto foreclosures in an effort to keep prices high. If you were a regular reader of this blog would understand this. And the recent splurge has been from foreign investors, especially from Asia, whom are fleeing what they are seeing as a collapse of their real estate bubble. Many are trying to find safe places to put their money.

Maybe instead of trying to fight with me, you out to ask how can 2.8 trillion dollar adjusted money supply support 14 trillion dollar economy without additional money creation?  Can we say defaults?  Can we say derivatives?  It's like musical chairs.  At some point there is a limit.  The question is not of the money supply in it's self but whether if there are enough people borrowing enough money to support the economy.  At some point this will end. Now if the Government were to end restrictions and taxes, then you would have massive inflation and you would have real growth.  But of course it owes over 220 trillion dollars in senior obligations, which cannot be possible paid.  So, they will further raise taxes and create more restrictions until they cannot anymore; this is deflationary.

 And who is doing the borrowing anyway, since so many people have some kind of experience with foreclosures. The velocity of money is decreasing because the masses of people are taking out less loans, not that there is no money being borrowed. There may be fewer people borrowing even more money or that there are more people borrowing smaller amounts of money so that they can eat.  Either way, there are lots of people losing their jobs which  means even less spending for them.

The fed is buying 85 billion dollars a month so that the government has a market to sell to. By law, the government can create its own market in with the primary dealers.  If there was enough money available (hint inflation) than it would not have to do this.  The fed is doing this so that the primary dealers do not deplete their banking reserves. It is all about protecting the primary banks and funding the government.

Cost are going up because many businesses are going out of business, subsidies are ending, and government restrictions are causing production cost to rise, not because of monetary inflation. And of which is because they have less money, not more.  It used to buy that one would just get a loan but no more.  In the absence of markets prices tend to rise.  Why? Because of diminishing returns.

I am not a deflationist. i just understand money and am being real about it. If the truth causes you discomfort, then your in for one heck of a future. After all, the fed is printing money for a reason. It would rather not do this.  And once this stops everything slows downs. The problem has been that too many people refused to live in reality. keynesianism is a false reality.  No one ever asks were the money comes from.  Even less understand the operations.


riphowardkatz's picture

the cause of the demand is an ever expanind supply of MONEY.

record borrowing by corporations
record borrowing by consumers
record borrowing by governments

but no one is borrowing. oh my. 

one more time. Please, please point to one fact just one(you avoided this again and again) that shows that there is less borrowing. 

also what is your investment thesis based on your understanding of money? 

TK69's picture

Again, you premise is flawed.  Monetary inflation is not the same as price inflation.  They are two separate entities.  And all one has to do is too look at the state of the economy if one wants evidence.  All one needs to do is to look at the fed actions afterall they are "quatitative easing" for a reason.  Or do you think they are doing it for the fun of it.

But what you really need to do is to understand the stats that you cite.  They do no show record borrowing by the masses.  You really need to look into the details. 

From the NY Fed:

While credit cards and short term obligations are on the rise, credit markets, home mortgages, and consumer debt are actually trending down. Why? Because people are payong off their debt.

From the Philadelphia Fed:

Money is created through loans. With less loans, there is less money that can be spent in the economy. And houses interject a lot of new money into the economy creating a boom.  This was the point of Freddi Mac, sub prime loans, etc.  To loosen loans standards so that more loans were made which creates a bigger boom. But even this money must be paid back but people want to avoid the bust, whichh is why the fed keeps bailing out the banks.  it is that simple.

 People need to borrow even more money that was created during the housing market in order to sustain an economy created by such a market.  And this is an imposablity since the bubble has burst. 

Quinvarius's picture

No.  Actually we are headed into hyperinflation.  Same as was stated in 2008.  Despite the desperate cries of the deflationists, the Fed is printing to bail out the banking system and fund the government.  These things cannot stop.  They can only grow.  Deflation theories are pure nonsense when there is a printing press.  And if we did have deflation, the USD would die immediately as all of our debts would default and there would be no money being destroyed in repaying them.  We would have instant hyperinflation instead of a high velocity inflation rise.

This is chess not checkers.

TK69's picture

ANd can you print your own money or know someone who does?  Does the Fed give you a weekly check?  The governmetn may in the form of welfare, but this only means that less people work and less things are produced as was seen in the soveit union.  

Hyperinflation destroys banks as well as nations, so there wil be default at some point.  And hyperinflation only exist if there are enough people who have an ever increasing supply of money to buy domestic goods with.  Buy how do they get this money?  That is the question.

You need to understand how money comes into cirulation and how it leaves.  Money sitting in bakning reserves only drive financial markets, governmetn bonds, and keeps super wealthy assets rising in value.  But it cannot be sustained.  There is a reason why the banks keep getting bailed out and a reason why the fed wants to have the wealth effect.  If not for this, if not without inflation, nothing can be sustained.  Thats right, at some point there will be default.  The government sells bonds instead of printing money becaue they need production (people producing goods and services).  And giving people money means less people working and less companies producing, which is how monopolies are created as well as mini somolia like states.


Hyperinflation occurs becaue goods are produced and imported, most likely becuase domectric trade is stymied.  But without importing, people who have the money find they have nothing to buy in such places.  Domestic companies shrink taking goods and serives with them while reducing paychecks, and profits (as well as taxes) which further shrinks the economy. It is what is commonly referred to a the collaps of the division of labor.



andrewp111's picture

Why does the Fed ever have to increase IOER at all? Before 2008, the Fed didn't pay interest on reserves - period! The whole point of IOR is to allow the banks to avoid losing money on FDIC fees when rates are zero.

Son of Loki's picture

excellent research.. thank you!

andrewp111's picture

This topic is geting more mainstream press. Here is an article linked on Drudge.

It is all based on a Fed paper where the Fed declared that it would raise IOR before selling assets. Maybe the best exit strategy is to simply stop adding new assets to the Fed's balance sheet.

Hedgetard55's picture

"FED gains or losses". What a hoot. They cannot have REAL gains or losses since they never used real assets to buy anything - they printed them up. The value of the printed money comes from the nick they take out of every other dollar in the system.


99.99% of Americans have no concept of real vs. nominal numbers. Some ZH readers do, however.

IamtheREALmario's picture

My, my, my the "coincidences" keep piling up. If one is a bible believer then one should pay some attention to God's judgment in Isaiah ... and then look up who and how many of our politicians have used the words from Isaiah 9:10 in speeches ... defying God.

God enacts his judgment on an unrepentent people every seven years if they do not return to God's ways.

That would make the next major crash in 2015, maybe even is September of 2015 and maybe even on September 11th... who knows for certain?

... and here we have a coundown clock for the Fed... lol. In the meantime, I am sure Lloyd will continue on, doing gods' work.

IamtheREALmario's picture

However, preparations could be being made to go back to God's ways. If the Fed accumulates all of the debt and then foregives it that would be in fulfillment of the instruction to foregive debt every 7 years.... if only 95 years late. The Fed could do this through a cessation of its existence.

There are some pretty hefty ramifications for this:

What happens to the reserves the Fed has with the banks?

What happens to Federal Reserve Notes?

What happens with a government that is hooked on deficit spending and cannot fund itself without the Fed?

Maybe the planned destruction of the Fed and a return to God's ways is what all the bullets are for ... although somehow that seems incongruous.

hooligan2009's picture

the impact on the market is that the fed has already cancelled the switching it for bank notes. 

bank notes = treasuries without coupons.

the fed simpy prints cash for fiscal deficits.

why central banks haven't done this since fiat money was invented is beyond me....governments can spend all they like and nobody need pay any taxes...ever..what difference does it make?

people would work with zero tax,,politicians would get all the pork barrel they wanted, and inflation/deflation growth.recession would adjust any excesses either way.

i mean really, what is the point of taxes and spending at all if the fed can prove that it can all be funded by printing bank notes to their buddies?

TK69's picture

The heart of the problem is mans fiat money (created through unimited finance).  It has replaced the money of God (commodity created through the limnited land).  Man has replaced the law of God with man (humanishm).   This is where to start such things.

Yes_Questions's picture



I got to admit.  I'm a little confused.  I understood the FED's roll as a currency creator in conjunction within a larger strategic initiative such as enforcement of the dollar's reserve currency status.  It faciliates creation of dollars, the US Military makes sure oil got traded using dollars, for example.  The Petrodollar regime.  And that the settlement of most international transactions would also use dollars, therefore.

Why would the FED's profitability be a concern when it is (soon to be was) the engine of world reserve currency creation?  The FED is a tool of the "member banks" for looting in the realm of consumer/commercial borrowing and the US Federal Government uses the FED for strategic intersts (my typed W. accent).


TK69's picture

The problem is that there are not enough American conusmers borrowing enough money to support the conomy, nor buying enough imports to sustaign the eocnomies of foreign countries. Profitablity does not mean anything.  They are trying to keep whole nations from unraveling.  ANd this means the end for them too and they know it.  Afterall, who will have ability to borrow money when all of this hits the fan?  How many people have it now.  The best that they can hope for is that the economy comes back and people start borrowing, while they keep protecting their "buddies' so too speak. 

Without borrowing money and inflating the money supply, there is no growth.  This is why the fed is buying so many government bonds.  There is not enough money to keep things going.  And with no infaltion nations, governments, financiers, member banks, large corporations can not finance their problems and cost away.  They have to face the reality of over coming diminishing returns which they cannot do in their present form.  They find out that they cannot afford themselves. YOu are seeing the beginning of the end of the so called state.  We are witness the ending of the illusion of prosperity brought to you by inflation.

Quinvarius's picture

If you are not buying gold here, you are crazy.  The pre-amble in the gold move is about over.  The last ten years were a warmup.

hooligan2009's picture

hmm...the graph says that 2 trillion out of 3 trillion of SOMA is held in floating rate securities. these have bugger all DV01. the fixed rate component has remained at c. 1 trillion for around 6 years.

this doesn't square with

the fed owns 1.7 trillion of fixed coupons (treasuries plus fed agency) and 1.0 trillion of (all?) MBS floating rate notes.


treasuries are simply bank notes with a coupon (intended to cover "matched" utility and risk between the government and the investor). 

given the dv01 in the article of $3.1 billion and a fixed coupon component of SOMA of 1.7 trillion, the implied duration of fixed coupons is 18.25 years.  

1.7 tn x 18 duration years/ 10000 = 3.1 billion

the 20 year bond (approx 18 year duration) has a yield of 2.8%. a better way to look at this is to "ball-park" a more normal 20 year yield. my guess is 5.5%. this makes for a move of 2.7% and a "loss" of 50% on the Fed's holdings of fixed coupons or c. $838 billion. 

the loss will approach 1 trillion dollars for a 2.7% increase in yields when the fed owns around 2 trillion of fixed coupons with a duration of 18 years. at 40 billion p.c.m, the fed will own 2 trillion of fixed coupon bonds in just 8 months.

since the fed is owned by the government, and the government is owned by the tax payer/citizen..the debt can simply be cancelled. it could be cancelled now. what is the point of saying one government department owns 1.7 trillion and another department owes 1.7 trillion?


I personally applaud the purchase of MBS, since these are (the net of) mortgages owned by US tax payers. I regard these as exactly the right kind of securities to hold in a rising interest rate environment at time when the sovereign credit is of increasingly dubious quality. I would switch all the treasury and fed agency holdings into these assets, since these have many more economic and credit risk protection characteristics than treasuries. they also provide people with a facilitating mechanism for owning their own houses.

what is not being done is the passing on of 0.25% fed funds rates to taxpayers and instead leaving a 3% or more mark-up with the government fraudie and funny (freddie and fanny).

this is a form of tax that is being imposed by the government on levered capital of citizens (200,000 mortgage x 3% mark up) and amounts to $6,000 a year tax in my book,

fraudie and funny ought to be making money hand over fist with the 3% mark up (lend at 3.25%, borrow at 0.25%). it looks like it is the agencies derivative books (another subsidy to the banking sector as these hedges are rolled via the usual suspect of JPM, GS, HSBC, DB and MS) that are reducing profits that should be going to the tax payer. 4 trillion agency book times 3% = 120 billion a year that should be being added to treasury coffers, less write offs.




Ian56's picture

Why the Federal Reserve is behaving like Nick Leeson and there is now no way out 


Nick Leeson and Barings bank vs the Federal Reserve and America

The Fed are behaving in exactly the same way as Nick Leeson, who kept doubling down on his bets that the Nikkei would  turn around and start rising again in the early 1990's.
The Nikkei was way over valued at the time - just like US Treasuries are now.
It was a sure fire losing trade.
Nick Leeson broke Barings Bank.
Barings Bank had been a profitable institution for 230 years - it was founded in 1762.
The Federal Reserve private bank is going to do the same thing to the whole of America.
America has also been a profitable institution for about 230 years.

The Federal Reserve's sure fire losing bet

The Fed is currently making healthy profits from it's greatly expanded balance sheet - $96bn for 2012.
But just a small rise in interest rates will turn these current profits into losses.

The Fed is now doubling and tripling down on a 100% sure fire losing bet (they are exactly akin to the worst kind of rookie trader).

They are increasing their balance sheet by $1tn a year ad infinitum, by buying US Treasuries at record high prices and overpaying for impaired mortgage debt in QE3.

WHEN (not if) interest rates start rising back towards normal historical levels the Fed will start making losses.
The longer the Fed continues with their current policy of buying huge quantities of debt at extremely high prices the greater these future losses will be.

Instead of returning a health sum to the US Treasury each year, the Fed will call upon the US Treasury (i.e. taxpayers) to pay for their losses. 

These future payments by the US Treasury to the Federal Reserve private bank have not been factored into future deficit or National Debt calculations.


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