Did Something Blow A Hole In The Fed’s Balance Sheet?

[Note:  A reader alerted me to this – LINK – which explains the $19 billion drop in Capital Surplus.  Congress passed a law requiring all surplus capital at the Fed in excess of $10 billion to be transferred to the Treasury as part of the Highway Bill passed in early December.  But does not change the thesis for the banking system underlying the analysis below:  the banking system is starting to collapse again from billions in defaulting loans – loans that banks refuse to write down in value, just like they refused to mark down the value of the collapsing mortgage derivatives trusts in 2008 per “The Big Short.”  It also calls into question the credibility of a Federal Reserve that is allowed and enabled to operate with just .8%  book capital – $39 billion in book capital against $4.442 trillion in liabilities covered by just $4.482 trillion in “assets.”  Finally, it calls into question the legitimacy of a Federal Government that continues to pass legislation for spending programs for which it has an increasingly diminished ability to fund. The analysis below is a snapshot of the collapsing U.S. and financial, economic and political system.]

The basis for this analysis is a video published today by Mike Maloney titled,  Is A Financial Crisis Being Covered Up?  My hats off to Mike for finding this data from the Fed because I would not have  otherwise been looking for it.  To help think about the analysis below, keep in mind that the Fed’s balance sheet is an aggregation of all of the Regional Fed balance sheets, which themselves are an aggregation of the banks that are members of each Regional Fed.   (Click on image to enlarge)


On December 23, 2015 the Federal Reserve’s Capital Account plunged by 65% – $19 billion – when the Surplus Capital Account dropped by that amount.  The Capital Account (CA) represents the capital required to be paid in (“Paid-In Capital) to the Fed when a bank becomes a member of the Federal Reserve system. Think of the CA as the “book value” of the Fed – assets minus liabilities.   The Surplus Capital represents “retained earnings” and the Fed is required to maintain Surplus Capital equal to 100% of Paid-In Capital. This requirement is set by the Board of Governors.  Currently, Fed interest earnings in excess of the required Surplus Capital and net of expenses is then transferred to the Treasury in the form of a dividend.

The 65% plunge in the Fed’s Total Capital Account, accounted for by the $19.4 billion drop in Surplus Capital, took the Surplus Capital account down to only 25% of Paid-In Capital (Total Capital minus Surplus Capital = Paid-In Capital).  This points to a large scale financial crisis that had to be addressed by allowing some of the Fed member banks to withdraw an amount of Surplus Capital well in excess of the amount required by the Fed’s Board of Governors.  Perhaps that might explain the Fed’s unscheduled “expedited, closed meeting” that took place on November 23.

Per the Financial Accounting Manual for the Federal Reserve Banks,  the primary purpose of  Surplus Capital is to provide a buffer against Paid-In Capital in the event of losses.  And there’s the rub.  Without having the benefit of even a modicum of Fed transparency, I would suggest that the $19 billion removed from the Surplus Capital account at the Fed was used to address collapsing energy-related loans (assets) sitting on the balance sheet of some of the big regional banks.  On the assumption that these assets fall within the 10% reserve ratio requirement, it would suggest that some or several regional banks – and possibly one or two of the Too Big To Fail banks – have sustained at least $190 billion in losses in their energy-related loans.  Or they are getting ready to take write-downs of that magnitude.

Interestingly, as I was getting ready to write up this analysis, a colleague with an energy industry contact in Canada called to tell me that he had just heard that CIBC is getting ready announce a big round of job cuts related to its energy banking business.  The insider at CIBC also said that the big hits to the Canadian banking system are still coming.

I would suggest that this information can also be applied to domestic U.S. banks as well. We already know that the Dallas Fed has instructed its member banks to refrain from marking to market their energy loans and from pulling the plug on energy company borrowers who are in serious delinquency or technical default.   We also know that Wells Fargo is somewhat admitting to sitting on an energy loan problem and that Citibank has an even bigger problem to which it is not admitting:  Wells Fargo Bad, But Citi Is Worse.

It’s been estimated that funded (i.e. junk bonds + bank loans + funded revolver debt) is probably in the $500-750 billion area.  Total including unfunded is over $1 trillion. More ominously, we have no possible way of knowing the size of the  OTC derivative / credit default exposure connected to that $1 trillion.   But we can safely say that it’s likely to be multiples in size of the actual debt in “nominal” amount, although every bank out there will claim to be hedged and thus the “net” is a small fraction of nominal.  I would suggest that “net” becomes “nominal” when counter-parties begin to default.  Just ask AIG and Goldman Sachs.

Given that there has never been a drop in the Fed’s Surplus Capital even remotely close to the 65% plunge that occurred the week of December 23, that sudden plunge in Surplus Capital at the Fed is somewhat shocking.  But,  given the probability that it is being used as an attempt to douse the lit fuse of a massive energy-related financial nuclear bomb in the form of defaulted energy loans and related derivatives, that drop in Fed capital is horrifying.

The BKX bank stock index has dropped 18% since December 23 vs. 7.5% for the S&P 500 in the same time period.  While all eyes seem to be fixated on Deutsche Bank’s stock, it would seem to me that we should be focused on the financial meltdown occurring behind the Fed’s “curtain” that is clearly going on in the U.S. banking system based on the sudden plunge both in the credit quality of the Fed’s balance sheet and the recent cliff-dive in bank stocks.  

The U.S. financial system is collapsing.  This is evidenced by the extreme recent volatility in the S&P 500, as the Fed fights the inevitable stock market collapse, and in the recent run-up in the price of gold and silver.  As a final thought to this analysis, I would suggest the possibility that the fraudulent silver price fix on the LBMA last week was a last gasp attempt by the big bullion banks to grab as much physical silver as they can, as cheaply as possible, before the price of gold and silver are reset by the market.  How else can you explain the 40% move higher in the HUI gold mining stock index since January 19?

16 thoughts on “Did Something Blow A Hole In The Fed’s Balance Sheet?

  1. Dave, please answer me a question: Why does the FED publish those charts as shown above? I mean, people like you clearly can analyse and understand them. People like you.. know that something is not right. So if something is really fishy behind the scenes right now, why would the FED not fake those charts to the “positive” side? I hardly can think of that they are not able to do it. Why do they risk that people start asking questions?

  2. This looks beyond ugly. Get the feeling that something really bad is getting ready to happen. That 2×4 that Dave mentions is getting ready to be swung.

  3. James Turk explained this on King World News.

    The Fed gave Washington $117 billion fiat bucks at the end of 2015.

    About $98 billion of that was the interest received on Treasury bills and notes from Washington … The other $19 billion was money that was supposed to go to the member banks that own the Federal Reserve – the $19 billion came out of the account used to pay the dividend to member banks.

    Instead, the politicians in D.C. wanted to fund this $305 billion five-year spending bill without increasing taxes. So they tacked a little-known provision to the Fixing America’s Surface Transportation Act, which President Obama signed into law on December 4th.

    The $19 billion was given to Washington to help fund the Treasury Highway Fund.

    1. Dave,

      Your AmazonDotCon short call is looking really good!

      AMZN down -27% since the recent high, now falling below it’s 200 DMA.

      The “FANGS” are slowly being pulled!

  4. Dave:

    FEDERAL RESERVE statistical release
    For Release at
    4:30 P.M. EST
    December 31, 2015

    Publication Note

    The Board’s H.4.1 statistical release, “Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks,” has been modified to reflect the policies under which Federal Reserve Banks make payments of their residual net earnings to the U.S. Treasury.

    The Fixing America’s Surface Transportation Act (FAST), which was enacted on December 4, 2015, requires that aggregate Federal Reserve Bank surplus not exceed $10 billion. Therefore, any amount of aggregate Reserve Bank surplus that exceeds this limit will be remitted to the U.S. Treasury.

    The line “Interest on Federal Reserve Notes due to U.S. Treasury” on table 6 has been replaced with “Earnings remittances due to the U.S. Treasury” and footnotes to tables 1, 5, and 6 have been similarly modified.

    The amounts of the line items “Other liabilities and capital” on table 1, and “Surplus” on tables 5 and 6 reflect the payment of approximately $19.3 billion to Treasury on December 28, 2015, which was necessary to reduce aggregate Reserve Bank surplus to the $10 billion limitation in the FAST Act.

      1. I tried to look for a cause like that but I didn’t look as hard as I should have because I had assumed that Mike Maloney’s worker bees had vetted the information.

  5. And many emerging markets could collapse too because they also took on debt leveraging their own economies to China’s growth and high energy and base metal prices. The banks also have bad emerging market debt as well as oil/energy loans. One huge clusterf*ck

  6. Thanks Dave for your keen insights on these crazy markets. I also saw a headline on CNBS stating that the IRS refund system was down and refunds would be delayed due to a computer glitch. They also said it should be fixed by this past Thursday. I truly believe that they system has already crashed and they are just masking it over. I always said the system is over when the IRS cannot pay out tax refunds to those who are to receive them. This is an early sign that things are at the peak of the blowout stage of this financial volcano.

  7. I’ve worked long and hard to make sure my tax refund is near zero.
    I can’t stand the idea of .gov using my money all year and then
    “refunding” it back like its some kind of gift!

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