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Holy smokes, the Federal Reserve, some say is uh going bankrupt. They are uh literally spending more money than they're taking in. Here's a quick glance at what I'm talking about. This just happened. See how there's a line in the middle and there's a zero above my head? Well, on the far right side, you see September 28th.
We just got info that the Fed is now upside down. That's right. The Federal Reserve can't even balance its income and expenses anymore. I feel like every day as normal individuals, we have normal financial wisdom that says we should spend less than we uh you know, we we take in, right? Well, the Federal Reserve, the most powerful central bank in the world, our Federal Reserve, is now officially upside down.
It's almost kind of like the people who have the most power in the world can literally go to us, hike our interest rates, hike rates on our cars, homes, credit cards, and tank our stock portfolio, and at the same time, they can make sure they got out right before the stock market crashed. Oh, because that's exactly what they did.
At the end of 2021, the board members of the Fed sold their stock portfolios because they wanted to make sure to avoid any conflicts of interest. Mhm, right. And then they proceeded to crash markets. So, what is happening and how does this work? Why all of a sudden is the Fed negative? And is this a big deal?
Like, is this bad? What does this mean for us? Well, let's talk about this because some are now saying because of this, the Fed's bankrupt and quite frankly, it's renewing calls to end the Fed. So, without further ado, let's talk about exactly what's happening. This video, by the way, is brought to you by Shortform, which will be linked down below and next to the link for the coupon code for the courses expiring tomorrow.
Make sure to get that lifetime access before it expires. But, more on Shortform later. So, first, every single day, the Federal Reserve pays money to institutions who deposit money with the Fed into either overnight reserve balances, so sort of regular reserve balances, or via reverse repo commitments.
Now, this is a little complicated. We're not going to go into all of the details of exactly what the reverse repo facility is. This is the St. Louis Fed website. I happen to be wearing a sweater from them. That's because, well, I thought CPI day, it's probably appropriate to wear this. I don't work for the Fed.
Uh but anyway, this is the reverse repo facility. And ever since about March 31st of 2021, there there were some rule changes at the Fed and with banks regarding their reserves. And essentially, the usage of this reverse repo facility has exploded. It's basically an opportunity for banks to take excess cash that they have.
So, extra savings that we've deposited with banks and that they have sitting around as cash, they're able to put them into basically the Federal Reserve's coffers overnight, and it goes back and forth every day, except when they get the money back, they get a little bit of interest. That makes sense.
The Federal Reserve currently pays interest not only on this repo facility, but also the other overnight reserves. And in total, there are about 5.2 trillion dollars in reserves the Fed has to pay interest on. Well, that interest rate used to be zero to a quarter of a percent. So, basically, it cost the Fed like nothing.
The total payment now, though, has changed. Now, they're paying about $469 million per day, every single day. And that'll go up to about $570 million when they raise rates to 4%. They'll have to pay that every single day. $570 million every day is worth like worth doing the math here. It's almost $24 million every single hour of every single day.
Or $369,000 every single minute. Or $6.6 thousand every single second. Yeah, that's like a new definition of making it rain every second. Six and a half thousand dollars or 6.6k, 6.6k, 6.6k. Yeah. That's what they're paying. And so you might wonder, okay, who's getting that money? Because that's crazy.
And again, it's mostly institutions parking your cash. Now, these were reserve balances are a lot, but the Fed also makes money. Most of the money they make is from the SOMA. Okay, SOMA is a little tricky, but it's a basically the system open market account. It's just a fancy way of saying it's where they park their Treasury bonds mostly, some other bonds, and mortgage-backed securities.
And those pay interest. Even back two years ago, you still had Treasury bonds paying interest. They were paying closer to 1 and 1/2 to 2% instead of like the 4 to 4 and 1/2% we're seeing now. And mortgage-backed securities pay some money as well. A lot less uh in the past than they than they do now.
Usually they'd make so much money on their SOMA just by basically printing free money, buying securities, right? Because that's quantitative easing, right? You print a bunch of funny money. You digitally print it. They don't actually print it like the Treasury Department actually prints money, but the Federal Reserve can digitally create money by on a spreadsheet like adding a zero so to speak.
Then they spend money on things like mortgage-backed securities and Treasury bonds. That cash then goes into the market because they can buy that money those those bonds so to speak from either the government, the Treasury Department, or from institutions like banks. So either banks get the cash that's created or the government gets the cash that's created.
And in the meantime, the Fed has these securities that pay interest. Again, Treasuries and mortgage-backed securities. Well, usually that makes a profit for the Fed. And the profit makes maybe somewhere around a billion bucks every single week or so that they end up having to send over to the Treasury Department.
Sometimes it goes up to 2 billion a week, sometimes uh it it's like $900 million, something like that. So, it fluctuates. What we could see over here is it's absolutely plummeted. In other words, the Fed is no longer sending money to the Treasury Department. This means that as long as the Federal Reserve continues to having to pay so much money on their reserve balances, they're not going to be sending money to the Treasury Department.
In fact, the Treasury Department really isn't expecting to get money anymore in 2022 that just started. Here's sort of an annualized picture of this. 2022, that's now negative. And they expect to be negative in 2023 and 2024 as well. Now, how does that work over at the Treasury? Well, basically, the Treasury Department has to borrow more money, which just increases the United States government's debt because the Treasury is now no longer getting a stream of income from the Fed.
Now, they do some magic math in terms of how they account for this between the two, but the practical matter is the less money that goes from the Fed to the Treasury, and the Treasury's got to pay tax or, you know, has to pay things like Social Security, right? COLA just went up, the cost of living adjustment was just 8.7%, so they got to pay Social Security, they got to send their stimmy checks, whatever they got to do.
All of that comes from the Treasury Department. If they don't have money for it, they just borrow more money. And since they're getting less money, they have to offset what the Fed used to send them by borrowing more money. So, basically, what happens here is the Treasury issues more debt while the Fed is negative.
And so, we've looked at this chart that shows us that maybe by 2025 and six, the Fed will be able to actually start paying the Treasury again when those reserve balances go down. And see, the Fed thinks that those reserve balances should go down because they think as they continue their process of quantitative tightening, more banks are going to take their cash and they're going to buy treasuries and mortgage-backed securities themselves, money will then leave markets, right?
This is sort of the vacuum cleaner of quantitative tightening. And when the Fed has less reserves on the book, even while rates are higher, the Fed has to pay lower interest rates. In this section here, they talk about how they're expecting the overnight repurchase payment facility to see a decline in the outstanding levels.
They say that could happen in the next coming quarters. So far, it hasn't actually happened yet. If anything, it's been slightly increasing, but we'll see. So the Fed is hopeful they won't be negative for too long as those numbers go down, but for now, they're negative. So what does that mean for us?
Well, let's get into a message from Shortform and then talk about the impacts of this. Now this next piece is brought to you by shortform.com/meetkevin. That's shortform.com/meetkevin. Now many of you know that I run out of time like all the time, okay? Like it's like time and run out of time have become synonymous.
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So, remember, shortform.com/meetkevin. Welcome back. So, the next thing that happens when the Treasury Department has to issue more debt because the Federal Reserve can't make money anymore cuz they're upside down and now they're costing the government more money. Remember, the Fed is technically separate from the government.
You're going to see calls reemerge to quote end the Fed. Ron Paul of Texas actually wrote a best-selling New York Times book on exactly this. Ron Paul is a believer that the Fed is corrupt, unconstitutional, and immoral. In fact, in his book, he says that the entire idea of the Fed arguing that they control interest rates, and basically by controlling interest rates, they can somehow impact markets, is almost the same as just having a centrally planned economy.
He kind of calls the Fed a centrally planned institution, kind of like the government of communist China, where the government controls wages and prices. In this case, it's the Fed, again, technically separate from the government. And he believes that is Ron Paul believes that a centrally planned economy is always failed, and that any intervention by a centrally planned economy just ends up creating a bigger hole.
Now, this is a big slap in the face to what Keynesian economics really is, which is what the Federal Reserve is essentially based on. Keynesian economics is basically what our Federal Reserve and our current government is based on. It stands in pretty stark contrast to the Austrian economics, who don't love what the Fed does.
They think the Fed creates more problems than it solves. This is kind of like Ron Paul. But basically, the idea is that an ordinary business cycle looks like this. Prices go up, prices come down. Prices go up, prices come down. And the problem with the business cycle, in the opinion of Keynesian economists, is that this creates too much euphoria, and this creates too much pain.
So, in the euphoric area, people take too much risk, and they go loony. During the pain periods, too many people lose their homes, their jobs, and their businesses close. So, the idea of Keynesian economists is, okay, well, why don't we try to soften these crazy times in market cycles by having a Federal Reserve that comes in and increases interest rates when the market is hot, and decreases interest rates when the market is low.
And the goal is to really soften the economic cycle, so that way we could have a more steady prosperity, rather than these crazy boom and bust cycles. Now, somebody like Ron Paul argues this is insane. The Fed, by stepping in like this, just creates more problems. And to some extent, this experiment we're going through right now, in 2022, kind of makes you feel that way.
Because after all, after COVID, we didn't save the economy from a hole, we way overstimulated the economy, leading to an insanely euphoric boom. And now, we have to we have way overstimulated the economy, and so we have to go in reverse, and so now we're really crushing the economy that shouldn't be crushed.
So, if you look at the pandemic, and now you're like, "The Fed hasn't smoothed anything. They just made everything worse." Now, obviously, hindsight is always 20/20. So, it's, you know, now what we could do is make fun of them, but going back, you know, if they knew what was going to happen, they probably wouldn't have done as much stimulus, and hopefully, they relax with their crazy crushing of our economy into a depression.
But, this is going to bring a lot of attention to people like Ron Paul, who say, "Screw the Fed. If businesses fail, let them fail. Let businesses implode, and stop bailing out companies." Because the ultimately, the idea is, "Hey, if businesses realize they're not going to get bailed out in boom and bust cycles, guess what they'll end up doing?
They'll end up saving more money, and they'll end up making themselves more resilient in the case of an economic collapse." So, basically, if you think the markets are going to fall, and somebody's going to bail you out, then who cares if you have a bunch of debt? But, if markets are going to fall and you know I ain't getting bailed out, then you may as well make sure you have enough savings to get through the down cycle.
Sure, other people are going to get hurt more, but the idea is companies and people save more money to survive through the bad times and so that way they don't have to go bankrupt because they know they're not getting bailed out. That means less spending during the euphoric times and so psychologically it might make sense that we actually have smaller boom and bust cycles without the Federal Reserve basically trying to bail stuff out when it looks like things are going bad, but then blowing up the economic cycle worse to where now they have to go in the opposite extreme, which is basically kind of what's been happening the last few years.
So, it's kind of interesting to revisit this whole idea of end the Fed when at the same time we are seeing the Fed now go negative and leading to more debt piled on to the United States Treasury Department, right? Now, there are plenty of people like Princeton economist Alan Blinder who say that there are, quote, "mountains of empirical evidence supporting the proposition that central bank independence produces not only less inflation but superior macroeconomic performance." That's a quote from him.
Great. So, there's a lot of research that says, "No, no, no, keep the Fed around." But, I hate to say it, when you look at the last couple years, you're like, "Really?" So, what's next? Well, here's basically what this means. When the Treasury Department has to essentially take on more debt because the Fed is upside down, it becomes a political issue.
That's it. We don't actually think that the Fed being negative has any real implications to us. It, practically for now, doesn't. It just means the Treasury Department has to borrow more money. And it's nice to know that there's not some kind of extreme result right now, but what will likely happen is a a of political pressure, like what I just explained with Ron Paul and then the Fed.
You're more likely to see more of that kind of pressure and more limitations potentially put on the Fed from Congress. Remember, the Fed is authorized to do its job as an entity that's separate from the government by Congress. So, Congress has the power to regulate the Fed and you could see a lot more political pressure on the Fed if we don't actually start seeing their policies working.
But in the meantime, the Fed is upside down. Thanks for watching, folks. Make sure to check out ShortForm by the link down below and we'll see you in the next one. And remember, those coupon codes, use those as well. Thanks. Bye.
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