Second in a series.
New York-President Obama should strengthen the financial condition of the Federal Reserve System soon, as a matter of urgency.
Rather than learning about looming challenges watching television while on vacation, our president actually should use his phone, his best financial minds and his pen to act decisively before the next phase in the debt crisis hits, not afterward, when solutions will be more difficult to implement and far more costly.
America faces ever more vexing dangers
In 2014, because American households, corporations, governments and financial institutions can borrow at interest rates that have been too low for too long, our nation remains addicted to debt, more than five years into a structural economic crisis that brings long-simmering geopolitical tensions to the boil.
At year-end 2013, America’s debt totaled $56 trillion, up 8 percent from $51.8 trillion at year-end 2008. This towering level hurts us less than it should because our central bank has been able to keep U.S. dollar-based interest rates artificially low.
Rising nations and resource-rich states understand mounting dangers of excess financial leverage and of Fed initiatives since 2008 that suppressed key U.S. dollar interest rates in hope of re-igniting global growth.
Many believe these policies actually compounded economic challenges inside and outside America, that no central bank or government can effectively manage.
For many reasons, America must now be fully prepared to defend the value of our currency as rivals and enemies force an end to the post-World War II status quo, when the U.S. government and currency reigned supreme.
But are we truly prepared for what likely comes next?
The biggest unresolved financial problem in America
While U.S. regulators and legislators roundly criticize 11 large American banks for their failure to plan adequately for looming disaster scenarios, America’s largest financial institution, the Federal Reserve System, seems the most vulnerable.
Since 1981, the Fed has been able keep key U.S. dollar-based interest rates on a downward trajectory — a path that inflated the recorded values of dollar-based assets.
At this moment, the U.S. dollar remains strong compared to most widely traded currencies — but conditions can change swiftly as we see in Russia, where the ruble is down 5 percent in one month and in Ukraine, where the hryvnia is down 7 percent during the same period.
Does the Fed have a large enough cushion to absorb inevitable losses when U.S. dollar-based interest rates get forced upwards?
According to the Fed’s 2013 Annual Report, the combined balance sheets of the Federal Reserve Banks had total assets of more than $4 billion and total capital of only $55 billion on Dec. 31.
As any experienced analyst will tell you, a low ratio of capital compared to assets is risky. In the case of the Fed, a 1.4 percent decline in the stated value of its assets would erase its recorded capital, rendering it technically insolvent.
Are conventions used in preparing financial statements for the Fed conservative, potentially masking hidden internal strengths?
As the 2013 report explains, financial information for the Fed and its constituent entities is prepared using special accounting principles. In a strict sense, therefore, these statements are not “audited” by truly independent and empowered third parties.
So, no one outside the Fed actually knows.
If the Fed required a sudden infusion of capital, could it count on its shareowners for assistance?
Unlikely, most American financial institutions would find themselves weakened, perhaps considerably so if the Fed itself encountered an adverse stress scenario. Meanwhile, the federal government has limited capacity to react to financial pressures that might cripple the Fed, after the fact.
One way to inject $1.0 trillion into the Fed
According to a Congressional Research Service report, titled “Federal Land Ownership: Overview and Data,” the government recently owned 628.8 million acres or 28 percent of nearly 2.3 million acres inside America’s 50 states.
Unless these lands are already pledged to support America’s government debt obligations (a condition that should be explained in full, if true), the president should be able to craft a plan to direct some portion of their realizable value as new capital into the Fed.
Thought through carefully in advance, such a plan might monetize substantial sums for productive purposes.
On the other hand, waiting to rescue the Fed this way amid a debt crisis in full force may prove impossible.
Next: Set global standards regulating U.S. financial markets