By Howard Schneider

AMELIA ISLAND FL (Reuters) – The Federal Reserve may lose any mortgage-backed securities that it holds, Loretta Mester of Cleveland Federal Reserve said Tuesday. This is a problem at best politically for the central bank as it remits all of its annual profits to U.S Treasury.

Mester commented at an Atlanta Fed conference that “a potential drawback to sales is that depending on the interest-rate path, they could lead to realized market–to-market losses.” These losses will not pose any operational problems for the Fed when it sets monetary policy. These losses would however present communication issues that must be properly addressed.

Some Members of Congress continue to question the Fed on their risky investment in building a huge inventory of bonds and mortgage securities. These assets were bought to stabilize key financial markets in the wake of the 2020 pandemic. However, the Fed is working towards lowering its influence in these markets as part of its current effort against inflation.

The risk of losing assets that have not reached maturity is negligible, however sales are subject to market conditions and the interest rate of the day.

A ICE index of mortgage-backed securities (NYSE:) is down by about 9% over the past year.

Mester’s statements do not represent the probability of selling. However, Fed officials want to see their balance sheet primarily comprise Treasury securities and get rid of as much or all of $2.7 trillion worth of mortgage securities.

Fed officials will begin to decrease their almost $9 trillion debt next month by using the proceeds from maturing Treasury Securities and repaid Mortgage Securities. Instead of investing the proceeds in new projects, they plan on taking that cash out of the system.

The Fed estimates that the monthly reductions in Treasury securities could reach $60 billion, which is the limit they expect to achieve each month. Mortgage securities can be reduced by up to $30 billion.

Due to the slow repayments on home mortgages, Fed doesn’t expect to meet this cap every month. However, Fed has suggested that MBS sales may be possible to achieve it.

MBS could be sold to “speed the return, or our portfolio’s composition”, which would allow us to hold mostly Treasury securities.

Home mortgage interest rates are rising so it is possible that the selling price of these securities has fallen. Buyers may be willing to take a reduced rate in exchange for mortgages with a smaller payment stream.

Mester stated that this would “lower the Fed’s remittances the Treasury”.

She stated that the Fed would “be watching developments in money markets” to determine how much the balance will shrink.