Echo

Just in case you missed it: the Fed said outloud that it may buy Treasuries

Monday, December 1, 2008

The crisis/panic/mahem, I don't know what to call it these days, has moved to its next phase. In an effort to slap some funding into the hands of the Treasury and to reduce the cost of corporate borrowing, Bernanke said that he may purchase Treasury debt (or agency debt) on the open market in "substantial quantities".

It is official - again - that the Fed plans to monetize government debt. But why wouldn't it? This is the next phase of the Fed's dropping each and every liquidity trick into the economic bucket.

The 10-year Treasury is trading at 2.72%, which certainly a record low. If the Fed succesully drives the 10-yr down another whopping 1.5% let's say, then where does that leave the cost of corporate borrowing? On November 28, the Moody's Baa investment grade corporate credit yield was 9.03%, and if the Fed's measures tighten investment credit by the same 1.5%, then the final cost is 7.5%, or just a 16% discount. I certainly wouldn't run to that sale.

Ben Bernanke should be using his power as a closely-followed public figure to pressure Congress to pass their $500 billion stimulus bill quickly. Bernanke & Co. cannot do this on their own!

From Bloomberg:

Federal Reserve Chairman Ben S. Bernanke said he has “obviously limited” room to lower interest rates further and may use less conventional policies, such as buying Treasury securities, to revive the economy.

The U.S. economy “will probably remain weak for a time,” even if the credit crisis eases, Bernanke said today in a speech in Austin, Texas. While the Fed can’t push interest rates below zero, “the second arrow in the Federal Reserve’s quiver -- the provision of liquidity -- remains effective,” he said.

Bernanke has created more than $2 trillion of emergency lending programs in the past year, using the Fed’s balance sheet and money-creation authority to cushion the economy from the worst financial crisis in seven decades. The central bank may lower its benchmark interest rate to zero and pump even more funds into the banking system, economists said.

“Although further reductions from the current federal funds rate target of 1 percent are certainly feasible, at this point the scope for using conventional interest-rate policies to support the economy is obviously limited,” Bernanke said in prepared remarks to the Austin Chamber of Commerce.

One option is for the Fed to buy “longer-term Treasury or agency securities on the open market in substantial quantities,” Bernanke said. “This approach might influence the yields on these securities, thus helping to spur aggregate demand.”

Treasury prices rose on Bernanke’s remarks, with yields on 10-year Treasuries tumbling about 10 basis points to 2.74 percent and two-year notes dropping to 0.85 percent. One basis point is equal to 0.01 percentage point.
RW: If this works, then Ben Bernanke would have pulled the biggest rabbit ever out of his hat. All I see is policy makers running around with their tales between their legs. It's the real economy that matters - we need Congress.

Rebecca Wilder

8 comments:

Janie December 1, 2008 at 3:51 PM  

It just doesn't seem like the Congress will act until after the inauguration. Then they can pretty much do exactly what the Democrats want which is not true for action now. There is too much compromise needed to get anything done before January. The long Christmas vacation won't help, either. Let's just pray Benanke's hat does produce a rabbit (giant size!)!

Anonymous December 1, 2008 at 5:09 PM  

Unfortunately, this is getting ridiculously out of hand. Sooner or later, we will reap what we sow, and I fear the outcome will be very unpleasant.

Stevie b. December 2, 2008 at 3:34 AM  

Rebecca - all these actions seem to = variants on pointless pushing on the same bit of string. What do you think the ramifications would be if the Fed and the ECB (and perhaps the B of E and the BoJ?) said they were -gulp- buying gold?

Rebecca Wilder December 2, 2008 at 10:42 AM  

Hi Stevie B.

How are ya?

Please don't bring up gold - that brings up notions of a gold standard...which would be bad.

Rebecca

Stevie b. December 2, 2008 at 2:09 PM  

Rebecca - fair enough. I was trying to think outside the box and a gold standard was the furthest thing from my mind, but I certainly wont labour the point. Cheers!

Rebecca Wilder December 2, 2008 at 2:36 PM  

Hi Stevie B.

How about the Fed buying below-investment grade debt from the corporate sector? That's definitely out of the box!

Rebecca

Stevie b. December 2, 2008 at 3:35 PM  

Rebecca - why not, but then where does targetting end and largesse to all and sundry begin?

I worry that the present inadequate contents of the medicine cabinet may only lead to a brief recovery of the patient, before a relapse brings on an even greater pandemic. Somehow, we need the modern equivalent of electric shock therapy, but even then maybe the patient is still too far gone down the dissolute, debauched road to respond.
Oh happy days!

Flow5 December 2, 2008 at 6:06 PM  

MONITIZE "real investment". I.e., if monies represented by a deficit are spent on projects which increase productivity and reduce waste, deficits are beneficial no matter how financed.

The initial inflationary effects of bank financing are quickly overcome by the larger output and lower unit costs. Debt incurred which reduces unit costs of production and promotes the health and welfare of the population obviously is "good" debt.

Debt incurred to finance transfer payments (interest, pensions, etc.) is of dubious quality. Any enterprise, private or public, is in dire straits if it has borrowed in order to make such payments.

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