It's Not Just the Obama Administration Flouting the Law, So Is the Fed–Part One

By now everyone knows that the Obama administration is deliberating choosing to disregard some laws, most notably Obamacare and immigration statutes, among others. By contrast, the Fed’s extra-legal moves have gone almost completely unreported by the press.

For example, the Fed recently issued its annual report. Some news stories focused on the big unrealized loss ($53 billion) in its securities portfolio, but none noted the illegal way in which the Fed created this loss.

One story described Republican critics of the unrealized loss as “unsophisticated… primitive… [holding] childlike beliefs about monetary policy.” Don’t they know that the Fed contributed $79 billion to the Treasury last year, a sum larger than the unrealized loss and a big help for the federal deficit?

Let’s dig a little deeper here. How exactly did the Fed generate that payment for the Treasury? First, it created money out of thin air. Second, it used the new money to buy bonds from Wall Street, the same bonds that Wall Street had earlier bought from the government. So in effect, the government bought its own bonds with new money it had created. In effect, the government had borrowed from itself, but in a way that was intentionally hard to follow.

It is not just nonsensical for the government to borrow from itself. It is also illegal. But when it is done in this indirect way, using Wall Street as an intermediary, it is technically legal. Since this sleight of hand is considered legal, this is not what we mean when we say the Fed has been operating illegally. We have to dig a bit deeper still.

As most people know, the Fed has been buying trillions of dollars worth of bonds with newly created money since the Crash of 2008, and also buying riskier bonds. As noted by leading Fed analyst John Hussman, the Fed violated Section 14(B) of the Federal Reserve Act when it bought $1.5 trillion of Fannie Mae and Freddie Mac mortgage bonds not explicitly guaranteed by the US government.

Holding risky bonds means that the Fed can incur a loss on their sale. That is why it has reported $53 billion in unrealized losses at the present time. Moreover, these losses can multiply depending on what happens to interest rates and other factors.

Why should we care? For one thing, the Fed illegally issued a note to its Statistical Release H 4.1 on January 6, 2011 stating that any of its losses would henceforth be a liability of the Treasury, that is, a liability of the taxpayers. So, if the Fed gets in trouble running its giant hedge fund-like operations, taxpayers will be expected to bail it out.

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Hunter Lewis is co-founder of AgainstCronyCapitalism.org, co-founder and former CEO of Cambridge Associates, a global investment firm, and author of two recent books, Free Prices Now!, about the Federal Reserve, and Crony Capitalism in America 2008-12.