The Fed needs to get its wallet out

June 12, 2009

Christopher Swann— Christopher Swann is a Reuters columnist. The views expressed are his own —

The Federal Reserve is putting on a brave face about the rise in Treasury yields.

At the moment, the Fed can afford to put off bringing out the big cannons for a little while. If market optimism is overdone, a few weak economic releases would soon send interest rates plunging again. If the market is right, then higher rates are justified and the economy will cope.

But Fed policymakers, who next meet in two weeks, should be getting the artillery ready. They have already promised to buy as much as $300 billion of Treasuries before September.

Unless rates come down swiftly, this limit should be increased substantially.

So far, the Fed has managed to confound the skeptics of their unconventional monetary policy.

Fed intervention breathed life back into the commercial paper market and the program appears to be winding down. The purchase of mortgage securities has driven the spread between 30-year mortgages and Treasury yields down to pre-Lehman levels. The result was a spurt of mortgage refinancing.

Thursday’s rally in Treasuries notwithstanding, the recent run-up in yields is now threatening this great achievement.

Refinancing of home loans has already halved over the last two months and may grind to a halt. Around $3 trillion of Fannie and Freddie debt has a coupon of more than 5 percent.

With rates on a 30-year mortgage rising above 5.5 percent, it no longer makes sense to refinance. Mark Zandi of Moody’s had expected Americans to save up to $30 billion in 2009 by locking in lower rates. This would require the fixed-rate mortgage to stay under 5 percent.

The rise in rates will also damage several federal programs aimed at kick-starting the housing market. The Homeowners Affordability and Stability Plan was created to allow those with very limited home equity to refinance. There will be few takers at current rates.

Similarly, the $8,000 tax credit for new homeowners expires on December 1 and will be largely wasted unless rates decline.

Against these possible outcomes, an additional round of Treasury purchases by the Fed poses relatively modest risks. The threat of an adverse market reaction — with nervous creditors dumping Treasuries and the dollar — is overdone as is the fear of inflation.

So far the Treasury Inflation Protected Securities suggest that investors have confidence in the Fed’s ability to keep inflation in check.

Even if the Fed buys its full quota of $300 billion in Treasuries it will still own less than 5 percent of the $6.6 trillion of outstanding market.

It can afford to buy much more before suggestions that it is monetizing the debt are to be taken seriously. After all the Fed is planning to buy $1.25 trillion in mortgage-backed securities by the end of the year — leaving it with up to a quarter of the total, according to Louis Crandall, chief economist at Wrightson.

The Fed still has great credibility, accumulated in the decades since it vanquished inflation under Paul Volcker. Now is the time to spend some of this credibility.


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It seems counter-intuitive, but somewhat higher rates can be helpful if we do not try to mitigate the impacts. Only children wish for perpetually sunny days. Grown-ups know that without rain, all terrestrial life starts to die. If we have a hundred companies struggling to survive, we risk losing all of them by having unusually low rates. So essentially I am saying that Greenspan did contribute to the current crisis by attempting to fix it. Similar situations happen all the time. The government once tried to end IBM’s monopoly on PCs. Their actions directly created another monopoly called Microsoft.

Interest rates create stress on companies. Without stress, even really weak businesses can stay in operation. That seems good, but these companies then continue to compete and divide the market against stronger companies. The workforce over time become adversely distributed over a disproportionally large number of weak companies. So I am talking about the auto sector as an example. Now we risk a severe catharsis or period of reckoning when we try to raise rates.

When people in government surround themselves with the same sorts of workers, the perspective never changes. That is really dangerous. Because their underlying assumptions about everything might actually be incorrect. It happens. IBM was forced to license out its architecture. PCs became the prevailing computer. These computers all used DOS. The government created a giant monopoly that decimated most of the competition.

Industries need higher rates. Then governments around the world must have courage. Because if they interfere, nothing has really changed. Rates will cause companies to go bankrupt. People will spend less at least in the short term. But with the Buy America policy in place, the dollars will still be spent domestically. Then maybe the next job that unemployed guy gets will be with a company that can withstand higher rates. It can do so because of reduced competition. To me, that all means greater job security and long-term stability.

Posted by Don | Report as abusive

THE FED HAS NO CREDIBILTY ! Remember Ben saying last August that the subprime efect would be imited. THAT’S RIGHT HE HAD NO IDEA ! Then Lehman. BEN WISHES HE COULD OF DEALT WITH THAT DIFFRENTLY NOW ! Now “green shoots” BEN THEY ARE ACTUALLY WEEDS ! For Ben to have any credibilty he must stop;
1. printing money
2. mark to fantasy accounting
3. buying bonds
4. talking

Maybe Ben ould buy some cred from a NBA player

Posted by gd | Report as abusive

The Federal Reserve is already monetizing debt. Anybody who claims otherwise is being disengenuous.

The Fed’s buying about a third of the Treasuries being issued during the period and as much as 150% of the agency mortgage debt being issued during the last year.

Posted by Les | Report as abusive

Honestly I’ve always thought the fed should be automated or done away with. The people running those bodies work in the interests of the business sector and Washington by default because that’s where they come from.

Don, you seem to have a very good understanding of what’s going on. I suggested that the government take the money that normally goes to poorly run social programs and disburse it evenly to the population as a financial safety net. I was told this is a bad idea and that it is unworkable. Do you believe this is true? And if so, can you explain to me what I’m missing that I don’t understand?

I’m not a student of economics but so far the actions of the government seem counter intuitive.

Posted by Benny Acosta | Report as abusive

With as much respect to the author as I can manage… screw you.

Everyone is such a fan of spending, spending, spending. Print money, borrow more, just do it because it you don’t, the world won’t recover.

But where are peopole like you when the politicians on the other side of the aisle start yelling about overspending and fiscal discipline? You’re right beside them, cheering the merits of tax cuts and calling for small government.

We’re squandering our opportunity for meaningful, substanative change in America by shouldering the burden for overspending whose only purpose is to allow a dying system another go at irresponsibility. Nothing is changing; more spending, more bailouts, and what do the investment banks do? They bid up the price of oil on speculation, determined to make those million-dollar bonuses even if it crushes the life out of a recovery, no concern for the tens of millions of people who are out of work because of their games.

The Federal Reserve has spent more than a trillion dollars off the public books, accountable to no one. The Treasury has funded more still, and what do we see? Rising gas prices, falling employment, and lobbyists arguing against regulation of financial fraud so they can spin it up again.

So to hell with you, all of you. Let the world go bankrupt; that’s where its policies and priorities and greed have led. When the ashes settle, and all of the greedy fat cat traders find themselves on the streets alongside the very people they put out of work over the decades through calls for higher and higher profits, then we can see where we might start over.

I refuse to be used to cover the pride and mistakes of people who make fortunes treating me like my life doesn’t matter.

Posted by Jamie | Report as abusive mention….. “But with the Buy America policy in place, the dollars will still be spent domestically”….as it stands today with my wages pretty much stagnant and with the threat of losing a job for many Americans a reality…..I can’t afford to buy American products as sad as that may sound…… finding anything made in America is pretty much a challenge today… order to get America buying American is to lower it’s workers wages in comparison to the rest of the global world…..seems painful to me

Posted by Mr. Anderson | Report as abusive

Great story, Chris!
What do you plan to tell your children when they realise that they will be the ones who will eventually be paying for the irresponsible actions of our generation?
I will give you the first paragraph to leave for your own son/daughter…
“It’s like this. We(generation) made LOTS of mistakes. We didn’t want to own up to those mistakes, pay our duties for those mistakes, allocate the blame and punish those infingements… NO, we continued on our merry way, pushing the same course that created this initial problem, which only multiplied the eventual chaos and carnage which you my dear child will be paying for for the rest of your life!”
“And by the way, son, I personally was a cheerleader of that movement!”

Posted by Eugen | Report as abusive

It looks to me like the various governments around the world are bent on propping up the big, old elephants (who have become “the establishment”). Wouldn’t it be better to let them trundle off to the elephants grave-yard to make space for the baby elephants?
I was amused by Don’s assertion that government intervention created the Microsoft monopoly, there were plenty of computers around at that time that used DOS, what Microsoft did was by hook or by crook, largely due to the ignorance of legislators at the time to understand software issues, to invest in pricing out the competition, often by investing in “Free” inferior versions of competitors offerings. However Microsoft and the consumer tech sector (phones, games etc) is a good example of baby elephants at the time which has created much of the growth market of the last couple of decades. Whereas I don’t see the tech sector necessarily being the answer to future growth (making a big elephant bigger is harder than making a baby elephant bigger), I do view it’s past performance as representing what allowing baby elephants to grow can achieve. To me energy and transport would seem to be potential fields for baby elephants as the current models seem to be unsustainable (and/or dangerous). Trying to revive a mortgage backed economy strikes me as an exercise in making the same mistakes hoping for a better out come next time.

Posted by Peter H | Report as abusive

The problem with central regulated stimulus driven “green spots”

The problem with central regulated stimulus driven “green spots” is that they only last as long as the stimulus is being given. Stopping the stimulus is like stopping water to your fresh green sprouts. The green dries and dies off and this is exactly the same as whit keeping your long interest rates low.

However the FED already had planned to buy as much as $1.25 trillion in mortgage-backed securities by the end of this year and $300 billion of Treasuries before September which still is less than 5% of the total of $6.6 trillion in the outstanding market. Source: (Reuters) The Great Debate – The Fed needs to get its wallet out

But the U.S. banks are insolvent cause that’s the main reason why the stress test definitely wasn’t and couldn’t be “a solvency test.” The U.S. now is the big melting pot calling the kettle black in urging Europe for a “stress test” which in fact in the American version was merely a biding time, jurist mind, word gimmick. Geithner cunningly was able to avoid this “bad bank” ditch in which the Germans have digged themselves now by taking this “stress test” far to seriously and actually trying to expose themselves by the “bad bank”- slush fund idea which was immediately rejected in the U.S. after they discovered it could cost them up to $4 trillion. Remember that if you are at a Poker table and you don’t know who the chump is, you’re the chump!

Inflation is not the problem now in a still declining economy and oil prices fairly low. Devaluating currencies, including the dollar, toxic assets, huge country deficits world wide, extreme volatility in the market, under capitalized insolvent banks still deleveraging, are. Long term investment already have been devastated by this global crises causing massive amounts of long term investment capital being destroyed. Much harm has been done by the banksters using and still using their toxics against the people and ordinary businesses. The answer could have been the Tulp Mania answer but who would listen to me back than and now it’s to late.

Bernanke has been caught between a hard and a rock place! Not spending will end the “green spot” dream immediately, long term interest go up and give more deflationary threats but on the other side of the evil coin can cause (hyper) inflation of the dollar if gross spending. But gross spending is needed according to their own Greenspan and clone Bernanke philosophy? A Faustian bargain but not to the Chinese who can easily absorb their foreign dollars into their massive solid savings rock bubble and just laugh to Geithner about it. Of cause everybody is praising the dollar now, we all want a soft landing but if it’s a hard one, the Chinese said, we just can take it.

Posted by Youri Carma | Report as abusive