The Fed Is Attempting to Defuse the Financial Bomb It Created... It May Be Too Late

Broken Financial System, Losses, and Ticking Time Explosives

“The Federal Reserve, with its unlimited power to create money, has done more to distort and destroy the American economy than any other single factor."

~ Ron Paul

The Fed is gearing up to stoke inflation again.

The obvious reason for cutting rates and firing up the money printer this year – with inflation still on the loose, stocks near record highs – is that it could help Joe Biden win in the upcoming election.  I wrote to you about that in an essay last week.

But there's also another reason: Our financial system is all but broken.

Let me explain.

There’s this thing called the H4.1 report. The Fed puts it out every Thursday. Most people don’t give it a second thought. But I do.

If you open the latest H4.1 report from March 28, 2024, and keep scrolling down, you’ll reach item box 6: Statement of Conditions. In that box, the line that says “Earnings remittances due to the U.S. Treasury” is crucial. I underlined it in red in the image below.

This line represents the money that the Fed remits to the Treasury from its operations each week. That is, if it has any excess money. If it doesn’t, the Fed is operating at a loss.

Today, the Fed is showing a huge loss. And as you can see, as of last Thursday, the figure stands at about $160 billion.

In other words, the Fed is not making enough money to pay the Treasury anything. That’s because the value of its U.S. Treasuries is lower (and the rates higher) than the Treasuries that are maturing.

Now, since it’s the Fed, nobody cares.

But it’s a different story with banks.

Remember, banks, too, park their cash in U.S. Treasuries. When interest rates rise, bond prices fall which also creates “paper” losses on those Treasuries. If a bank is forced to sell the bond before it matures, then it realizes that loss.

The Fed’s higher rates of the past two years hurt the value of the Treasuries U.S. banks held for liquidity purposes. This saddled them with massive paper losses.

Now, this isn’t necessarily a big problem in normal times. Banks have ways of handling cash flow issues, even if they're dealing with paper losses.

But these times are anything but normal. The economy is wobbly, prices are soaring, real estate is a mess, and gold and stocks are both hitting record highs. This has depositors jittery. And when scores of them rush to withdraw their money at the same time, these paper losses turn into real ones. Quickly. And devastatingly.

Remember the failures of First Republic, Silicon Valley, and Signature banks from last year?

These banks went under because they couldn’t raise enough money unloading their Treasuries to pay back the depositors who were rushing for the exists.

A bank run is never a pleasant experience for bankers, but when all your cash is tied up in Treasury bonds that are deeply underwater due to the Fed's rate hikes, it could be terminal.

And here’s the big problem. U.S. banks as a group are currently sitting on $480 billion in unrealized paper losses on government securities. That’s what the next chart shows…

It’s an impressive figure, far surpassing the "paper" losses witnessed during the 2008 crisis.

In other words, the U.S. banking system is operating at a huge loss.

It’s like a ticking time bomb, just waiting to go off. You never know when the next bank run will happen. And when they do, you can bet those "paper" losses will really sink some ships. And, of course, the problem with bank runs is that they tend to set off a domino effect as panic spreads. If that happens, it’s bound to spill over into the broader economy.

Doug Casey: All these banks are bankrupt. If there’s panic, the Federal Reserve's only recourse is to print more money and give it to the banks. That’s all they can do. But once they have that money, it will create more inflation. So there's no way out. Actions have consequences. Cause and effect. Things will get much worse from here, I believe.

The Fed knows this issue all too well, so it's itching to help its bank buddies get back in the green on their Treasury bond holdings before it's too late...

But it may already be too late, especially when you see what's going on with regional banks amid the brewing commercial real estate loan crisis right now.

I'll have more to say about this in the coming weeks, but let's just say I'm already starting to see the panic spread through the system.

New York Community Bancorp (NYCB) is a case in point. The nation’s 28th-biggest bank with over $116 billion in assets under management recently reported major losses tied to souring commercial real estate loans. NYCB’s credit rating got downgraded to junk status, and its share price nosedived by a massive 74% just this year.

But it’s not just NYCB. Numerous other banks are trading at or near their lowest levels in two years, with their credit ratings downgraded. This shows how little confidence investors have in their operations, and soon enough, depositors will catch on too.

Until next time,

Lau Vegys

P.S. Doug believes that the Fed's move to cut rates and fire up the money printer this year will create a bubble in commodities. This is good news for one of the metals recently added to our Crisis Investing portfolio, and we're planning to include two more equity picks to capitalize on it.