Hussman Weekly Market Comment: Number Five

…..

Meanwhile, the balance sheet of the Federal Reserve presently comes to about $2.8 trillion, with an average duration of 7.3 years, meaning that a 100 basis point change in interest rates would be expected to impact the Fed’s position by about 7.3% on the basis of bond price changes. Now, keep in mind that the Fed presently has just $54.7 billion in capital, which means that the balance sheet is leveraged by over 50-to-1, or put differently, the balance sheet has just 1.95% capital coverage. The unpleasant arithmetic here is that a 27 basis point change in bond yields (1.95%/7.30%) would effectively wipe out the Fed’s capital. While the Fed doesn’t mark its balance sheet to market, and can therefore run an insolvent balance sheet without immediate consequence, it should at least be a subject of public understanding that monetary policy becomes fiscal policy 27 basis points from here. Over time, of course, the Fed earns interest on its bond holdings, and that interest is normally handed over to the Treasury for public benefit. Presently, a 30 basis point increase in yields over a one-year period would wipe out even this interest, at which point the government would be paying interest on its debt simply to cover the Fed’s losses, with no net benefit to the public. That is, unless one believes that the Federal Reserve’s manipulation of financial markets is of equivalent benefit in and of itself. We don’t, and it is likely that investors will discover that in an uncomfortable way over the coming quarters.