Monday, January 26, 2009

Six weeks later and not a whole lot has changed

Time flies. Just six weeks ago, the Federal Open Market Committee (FOMC) met to discuss current policy initiatives. At that meeting, the FOMC explicitly (or as I thought) identified its policy intentions (at least the Board of Governors' intentions):
  • "the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets"
  • "stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant"
  • "evaluating the potential benefits of purchasing longer-term Treasury securities"
  • And from the minutes, "size of the Federal Reserve's balance sheet would need to be maintained at a high level".

And since that meeting, the Fed has followed through with the following:

  • $17.97 billion purchase of agency debt ($24.16 it currently holds minus $6.19 held on Dec. 17th)
  • $5.78 billion purchase of mortgage-backed securities (MBS)
  • Bernanke is still "considering" Treasury purchase program

The Fed has not done a whole heck of a lot since its last meeting: $17.97 billion in agency debt holdings and $5.78 billion in MBS asset purchase hardly qualifies as "large quantities". And furthermore, the mortgage and housing markets are still in need of "support". Mortgage rates are essentially where they were one year ago, and home values continue to decline.

It makes me wonder what exactly is the Fed's next move? The FOMC's usefulness is all but done - the federal funds target is almost at zero - and it's up to the Board of Governors to follow through on their policy announcements. There is likely more dissent in the ranks of the Fed than the minutes of the December FOMC meeting revealed.

Whatever glimmer of light that emerged just one month ago seems to have dimmed a bit: mortgage rates increased slightly, libor is climbing again, and of course, the banking system has taken a turn for the worse. Is nationalization in the cards?

At any rate, it seems that the Fed is on a holding pattern, which of course, has not been explained. Wednesday's announcement is unlikely to move markets, however, the meeting's minutes (released later) may provide more clues. It's like playing the game memory - trying to piece together the clues provided incrementally by the Fed in order to ascertain what exactly is the Board of Governors' next move.

Rebecca Wilder


  1. Maybe they'll eliminate the policy of paying interest on reserves. That would be a big deal!

    I suspect that they've been taking a break mostly because MBS and Agency spreads have come down. Its a bit of "mission accomplished" thinking. However, mortgage rates are now headed higher, and so they may decide its time to get back to work. Eliminating interest on reserves would impact the variable that many are complaining about: falling velocity.

  2. If they are small enough to subsidize, they're small enough to nationalize.

    The liquidity trap will begin to end once the government, without the "mark to market" restriction, nationalizes the big insolvent banks and moves illiquid securities to warehouse. Then the government can take its sweet time figuring out pricing. There's plenty of unemployed investment bank traders around to work at the warehouse.

    Just doing a "bad bank" means the taxpayer has to pre-fund whatever "mark to market" number is placed (by whom?)on these illiquid securities. That's just a crude method of taxpayers' subsidizing bank bondholders. To the tune of hundreds of billions of additional dollars.

    The real reason there hasn't been nationalization already is that bondholders represent the cream of the crop in wealth. These are the folks who fund Congressional campaigns. This is the real reason Congress shudders when the word "nationalize" pops up.

    Nationalizing won't cost the taxpayer anything--at least compared to the "bad bank" scenario where bondholders are bailed out. Once the economy recovers, re-privatize the national bank into several private banks that are decidedly not "too big to fail."

  3. Rebecca, your post highlights some of my frustration. The Fed supposedly is pulling out the big quantitative easing guns, but continues to pay interest on excess reserves and as you point out above has not been terribly active. One wonders where the fiscal policy debate would be now had the Fed done more.

  4. I agree with both of you. IOR is completely counter-intuitive. Perhaps the Fed is worried about reducing its credibility by suddenly removing the interest on reserve policy (IOR)? Seems silly when credibility is the one thing that it seems to be lacking at this point (at least if you listen to Poole).

    I disagree – must be more than some small move in spreads….mass quantities? The Fed is single-handedly shoring up the commercial paper market – now that’s pulling out the big guns! It should have purchased more MBS by now - the bond market got all googly-eyed the day that the Fed made its first purchase.

    David Beckworth - thanks for stopping by – I read your blog frequently.