BREAKINGVIEWS-All together now, central banks do not go bust

Fri Mar 1, 2013 10:25pm IST

(The author is a Reuters Breakingviews columnist. The opinions expressed are her own.) (Refiles to fix links.)

By Agnes T. Crane

NEW YORK, March 1 (Reuters Breakingviews) - Central banks which control their own currencies do not go bust. Yes, the U.S. Federal Reserve and other central banks with bloated balance sheets are likely to book losses when interest rates rise. That must be why U.S. Senator Bob Corker this week asked Fed Chairman Ben Bernanke about the institution's solvency. But no amount of red ink should bleed them dry. That's because despite their name, central banks are monetary authorities, not really banks.

Their main job isn't to lend money. Central banks, instead, squeeze and pull a nation’s monetary base, trying to keep inflation low, growth high and the financial system stable. Over the past four years, the U.S. central bank, followed by peers around the world, has exercised that mandate by buying trillions of dollars of bonds.

That sounds expensive, but monetary authorities, unlike real banks, have no trouble finding the necessary funds. They simply create new money.

Take the Fed. It now has a $3 trillion balance sheet with just $55 billion in equity. If it were a normal bank, that would equate to leverage of 55 to 1, breaching capital requirements several times over. But it's not. Central banks don't need equity capital. They put it on the balance sheet for appearances.

There's the rub. Perception matters. Politics do, too. Earlier this year, Fed economists published a paper forecasting what will happen to its vast holdings of Treasuries and mortgage bonds when interest rates go up. In a worst-case scenario, the losses could run as high as $125 billion, leaving the Treasury with zero income from the Fed for six-and-a-half years. After receiving nearly $300 billion over the past four years, lawmakers are sure to squawk about the lost revenue.

Senator Corker's questions hint at the political battle ahead. If it gets heated enough, lawmakers could try to interfere with monetary policy in the middle of what’s sure to be a complicated exit. That would be unfortunate. The European Central Bank, however, may even have it worse. Political pushback could jeopardize its ability to recapitalize, since all member countries must agree to an equity injection.

And this is where the danger resides: not in a central bank's solvency, but in the public's perception. If Bernanke and others aren't persuasive enough to allay concerns about losses, the QE experiment could come to an ugly end.

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CONTEXT NEWS

- U.S. Republican Senator Bob Corker sent a letter to Ben Bernanke asking the Federal Reserve chairman to explain the policy implications of a large central bank balance sheet. The letter followed an exchange between Corker and Bernanke during his semiannual congressional testimony on Feb. 26.

- In 2012, the Federal Reserve paid $88.9 billion of its estimated net income to the U.S. Treasury.

- In January, the Fed released a study on the effect of rising interest rates on its balance sheet and earnings. In a worst-case scenario, the economists found losses would reach $125 billion if interest rates increased by 3 percentage points. In that case, remittances to the Treasury would cease for six-and-a-half years.

- Corker letter: link.reuters.com/keb46t

- Fed study: link.reuters.com/meb46t

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- For previous columns by the author, Reuters customers can click on [CRANE/]

(Editing by Edward Hadas and Martin Langfield)

((agnes.crane@thomsonreuters.com)(Reuters messaging agnes.crane.thomsonreuters.com@reuters.net)) Keywords: BREAKINGVIEWS CENTRALBANKS/

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