The fed has a balance sheet that consists of bonds of varying maturities mostly. During covid the balance sheet exploded as they bought all sorts of mbs securities and bonds to loosen liquidity. By definition that was basically the exact opposite of what a rational person would do acting in his own best interests, but it’s what they did at first to restore order to credit markets and then after that because they thought that’s what people wanted them to do.
But now those bonds have gone massively underwater because of their own policy- they have drastically raised interest rates on shorter duration bonds while simultaneously stopped buying bonds. So the value of the assets they hold is drastically diminished.
But the fed also borrows money on the short end from banks through the reserve program. Banks keep excess reserves at the fed and the fed pays them interest. In a normal environment that’s not a problem because long bonds usually yield more than short bonds. But because the fed loaded up on low yield bonds they have a negative carry so they are losing money now. Normally they would pay the excess to the treasury but now they have to borrow from it.
The interesting thing is that this is basically what sank svb but on a much larger scale. The difference is obviously that the government can print its own money.
But now those bonds have gone massively underwater because of their own policy- they have drastically raised interest rates on shorter duration bonds while simultaneously stopped buying bonds. So the value of the assets they hold is drastically diminished.
But the fed also borrows money on the short end from banks through the reserve program. Banks keep excess reserves at the fed and the fed pays them interest. In a normal environment that’s not a problem because long bonds usually yield more than short bonds. But because the fed loaded up on low yield bonds they have a negative carry so they are losing money now. Normally they would pay the excess to the treasury but now they have to borrow from it.
The interesting thing is that this is basically what sank svb but on a much larger scale. The difference is obviously that the government can print its own money.