The Federal Reserve lost $77.6 billion last year! Consecutive losses for two years, with interest rate hikes as the main culprit

The audit results of the Federal Reserve's financial statements for 2024, released on Friday, show that following a loss of $114.5 billion in 2023, the Federal Reserve incurred an operating loss of $77.6 billion last year, marking a significant loss for the second consecutive year.

Media reports indicate that these losses are a side effect of the Federal Reserve's substantial economic support during the pandemic in 2020 and 2021, as well as the significant interest rate hikes implemented in 2022 and 2023 to combat high inflation.

The losses will not lead the Federal Reserve to request funds from the Treasury, nor will they affect its daily operations. This is because generating profits and earning interest income are not the Federal Reserve's direct goals, but rather a byproduct of its monetary policy operations. The Federal Reserve's objectives are to maintain low and stable inflation and a healthy labor market.

Rate Hikes Lead to Surge in Interest Costs

Until 2022, the Federal Reserve had almost consistently been profitable, often returning substantial profits to the U.S. Treasury during the previous decade of low interest rates. However, in the past two years, due to higher interest rates, the Federal Reserve's costs have exceeded its income, a result of some complex mechanisms used to set short-term interest rates.

The Federal Reserve's balance sheet includes assets such as government bonds and mortgage-backed securities, from which it earns returns like other investors. On the liabilities side, it includes deposits from banks at the Federal Reserve, known as "reserves," for which the Federal Reserve must pay interest.

Since 2022, the Federal Reserve has rapidly raised interest rates, continuously increasing the interest paid on reserves to financial institutions. By September of that year, the interest paid by the Federal Reserve had surpassed the income generated from its securities portfolio.

As a self-funding institution, the Federal Reserve does not receive a budget from Congress. It pays all operational expenses from securities income, with any remaining surplus remitted to the U.S. Treasury. The Federal Reserve also provides funding support for the Consumer Financial Protection Bureau (CFPB). Under the Dodd-Frank Act of 2010, Congress requires the Federal Reserve to fund this agency.

Unlike other federal government agencies, the Federal Reserve is not required to seek congressional approval to cover operational losses. Instead, since 2022, the Federal Reserve has established an internal account called "deferred assets." When it is no longer incurring losses, the Federal Reserve will first use its surplus to repay these deferred assets before resuming the practice of remitting surplus to the Treasury.

Before the financial crisis from 2007 to 2009, the Federal Reserve's asset portfolio was relatively small. Subsequently, as the Federal Reserve held high-yield long-term securities while maintaining low short-term interest rates, its net income grew rapidly. Between 2012 and 2021, the Federal Reserve remitted over $870 billion to the Treasury, including $109 billion in 2021.

In the first nine months of 2022, the Federal Reserve transferred $76 billion in profits to the Treasury. However, losses began in September of that year, culminating in a recorded deferred asset of $16.6 billion by the end of the year. This deferred asset amounted to $133 billion in 2023 and has grown to nearly $216 billion in 2024.

Continuous Rate Cuts May Restore Profitability

When the Federal Reserve will return to profitability depends on whether and when it lowers interest rates below the current average yield of its $6.8 trillion in securities and other assets. The Federal Reserve has been reducing its balance sheet over the past three years The New York Fed's forecast last year indicated that if short-term interest rates remain above 4%, the Federal Reserve will continue to incur losses this year; if rates continue to decline, the Federal Reserve may achieve profitability. The current benchmark interest rate of the Federal Reserve is approximately 4.3%, down from 5.3% in early September last year.

Seth Carpenter, Morgan Stanley's Global Chief Economist and former Federal Reserve and U.S. Treasury official, stated,

"As time goes on, they are getting closer to the breakeven point. I find it hard to imagine they won't return to profitability, but it may take a few more years."

The root of the Federal Reserve's losses lies in its massive purchases of Treasury bonds and mortgage-backed securities during the COVID-19 pandemic to support the economy. These assets were primarily accumulated during the bond-buying stimulus programs implemented from 2009 to 2014 and from 2020 to 2022. According to Morgan Stanley's data, as of the end of last year, the weighted average yield on the $6.8 trillion in securities held by the Federal Reserve was 2.6%.

Currently, the interest rate paid on the $3.4 trillion in reserves by the Federal Reserve is 4.4%.

According to the minutes of policy meetings, Federal Reserve officials had expressed internal concerns about the political implications of being forced to raise interest rates quickly in the future and incurring losses on securities assets over the past decade