Does interest rate risk matter if you're the Fed?

Holding a mortgage investment portfolio bigger than Fannie Mae’s or Freddie Mac’s, along with a massively expanded government bond portfolio, puts the Federal Reserve into uncharted waters of interest rate risk.

The combined balance sheet of the Federal Reserve has $2.9 trillion in assets and $55 billion in equity, for leverage of a heady 52 times and a capital ratio of a paltry 1.9 percent. On top of this high leverage and little capital, the Fed runs massive interest rate risk, with investments in long-term mortgage-backed securities (MBS) of over $900 billion and longer-term Treasuries of $1.65 trillion.

“The huge and rising government bond holdings of Japanese banks leave them vulnerable to a spike in interest rates, the International Monetary Fund has warned,” the Financial Times reported recently. But somehow the IMF did not warn about the Fed’s huge and rising bond holdings, which leave the Fed vulnerable.

A rise in interest rates from their historic lows is inevitable at some point. How vulnerable is the Fed’s balance sheet to interest rate risk? We can estimate the market value impact of a 2 percent increase in interest rates, a common benchmark.

The full text of this article is available on The American's website.

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About the Author

 

Alex J.
Pollock
  • Alex J. Pollock is a resident fellow at the American Enterprise Institute (AEI), where he studies and writes about housing finance; government-sponsored enterprises, including Fannie Mae, Freddie Mac, and the Federal Home Loan Banks; retirement finance; and banking and central banks. He also works on corporate governance and accounting standards issues.


    Pollock has had a 35-year career in banking and was president and CEO of the Federal Home Loan Bank of Chicago for more than 12 years immediately before joining AEI. A prolific writer, he has written numerous articles on financial systems and is the author of the book “Boom and Bust: Financial Cycles and Human Prosperity” (AEI Press, 2011). He has also created a one-page mortgage form to help borrowers understand their mortgage obligations.


    The lead director of CME Group, Pollock is also a director of the Great Lakes Higher Education Corporation and the chairman of the board of the Great Books Foundation. He is a past president of the International Union for Housing Finance.


    He has an M.P.A. in international relations from Princeton University, an M.A. in philosophy from the University of Chicago, and a B.A. from Williams College.


  • Phone: 202.862.7190
    Email: apollock@aei.org
  • Assistant Info

    Name: Emily Rapp
    Phone: (202) 419-5212
    Email: emily.rapp@aei.org

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