The Fed Twists in the Breeze

Mr. Market so far is not at all impressed with the announcement today that the Fed will be changing the composition of its portfolio by selling $400 billion of near-dated Treasuries and buying the same amount of longer maturity Treasuries. Since the Fed will maintain the same Fed funds target rate, the Fed’s intent is to keep short term rates low and also reduce longer term rates.

The fallacy with the Fed approach, as our Marshall Auerback has pointed out repeatedly, is that targeting a quantity means the central bank has no idea what result it will achieve. An analysis by Jim Hamilton showed that $400 billion of QE in the past would have moved rates by all of 17 basis points, which is bupkis (and that’s assuming you think lowering of longer term rates further is a worthy goal when long term rates are already at historic low levels). From his 2010 paper:

We can summarize the implications of that forecast in terms of the following scenario. Suppose that the Federal Reserve were to sell off all its Treasury securities of less than one-year maturity, and use the proceeds to buy up all the longer term Treasury debt it could. For example, in December of 2006, this would have required selling off about $400 B in bills and notes or bonds with less than one year remaining, with which the Fed could have effectively retired all Treasury debt beyond 10 years. The figure below summarizes the implied average change in forecast for the 1990-2007 period as a result of this change for interest rates of various maturities. Yields on maturities longer than 2-1/2 years would fall, with those at the long end decreasing by up to 17 basis points. Yields on the shortest maturities would increase by almost as much. While our estimates imply that the Fed could make a modest change in the slope of the yield curve, it would not make any difference for the average level of interest rates. As we said, results may (as in will) vary, but the broader point is the last experiment of this sort produced underwhelming results.

And of course, to the extent the Fed is successful in flatting the yield curve, even modestly, this reduces the profitability of the basic operation of banking, which is maturity transformation (borrowing short and lending long).

Andrew Horowitz of The Disciplined Investor provided this side by side comparison of the FOMC’s last two statements (see here for his original):

FOMC Statements Side by Side, Sept 21, 2011

Print Friendly, PDF & Email


  1. Mogden

    Since active harm is the rule when it comes to our government these days, an empty gesture is by far the best we can hope for.

      1. CB

        Legally or informally? Informally, I think there is, depending on who’s where, a lot of cross linkage. Overlapping networks.

      2. scraping_by

        The Fed is doing a Constitutional function by coining money.

        It’s part of the government by function, remotely by governance, and by ownership not at all.

        If that sounds ugly, you’ve got a good ear.

        1. DanJS

          By “coining money” you mean stamping out precious metals coins of verified purity and standardized weights?

    1. Dan G

      It appears that they will reinvest maturing MBS into new MBS. I don’t know how much the rollover amounts to each month.

  2. CB

    From an ordinary person’s point of view–Hello, up there, anybody home?–low interest rates are another nail in the savings coffin. I mean, why put money into accounts that don’t even match inflation? RE, stock market, debt paper, all bad. So, where do ordinary people put their (few) extra shekels? In fact, if you have only a few dollars, what financial services company will even take them?

    1. MyLessThanPrimeBeef

      Here is one accouting identity.

      Total debt = Total credit.

      While one side benefits from lower rates, the other side suffers. It’s a zero-sum game.

      Another accounting identity –

      Total Responsible Debt + Total Irresponsible Debt =
      Total Responsible Credit + Total Irresponsible Credit


      Total Responisble Debt = Total Responsible Credit


      Total Irresponsible Debt = Total Irresonisble Credit.

      When the Irresponsible party suffers, the responsible party benefits. For example, when an irresponisble borrowing corporation goes bankrupt and its irresponsible bank writes it off, the others who have been responsible can continue to function without having to bail the irresponsible ones out. It’s a good kind of zero sum game.

      1. MyLessThanPrimeBeef

        By the way, if you want to see more credit in the world, you need more debt.

        And if the government prints more money, it means more money for the people sector.* So if you want to see a wealthier people sector, you print more money.

        Per the accounting identity –

        Money printed by the government and not held by the government (why would they even want to hold on to that?) = money people have + money lost to accounting erros/currency spoilage.

        1. solo

          @ . . .Beef: You are enamored of your a priori identities, which, being tautologies, say nothing about the a posteriori world. Let the symbol “->” stand for “implies.” Insert the real world into your equations and your flippancy sours: {Unlimited “money printing” -> [Future Value of (total debt = total credit) – Future Value of GDP] = inflation} -> economic instability + competitive devaluation + stagflation. –And this says nothing about the political outcomes, which would include further incitement to protofascist lunacy of the Tea Party sort, heightening of vicious antagonisms among the citizenry, further souring of international relationships, including the ever-popular temptation for more war, and so on.

          Paul Volcker had a timely op-ed piece in last Sunday’s (9/18) NY Times in which he warned against something like your thinking shaping up, in desperation, at the Fed–targeting a therapeutic 4-5% inflation rate by way of encouraging “animal spirits” a la Keynes. Volcker named nobody at Fed, but explicitly named “stagflation” as the likely outcome of such a delusional policy.

        2. chris

          maybe if you are basing wealth on the amount of paper money being held regardless of the value of that money. But increasing the supply of money does not make the people sector wealthier. That is completely false and makes no sense. The printing of money has been going on for a few years now and the money is going nowhere. If that is some economic theory it just proves economics is art and not even remotely a science. If printing money made people wealthier then we would never have a problem. It is not that simple however.

      2. harposox

        You’ve got it almost right, but not quite. Total debt IS ALWAYS > total credit, because money is loaned at interest. Which has a few interesting consequences. For instance, the “national debt” can never be paid off, because there aren’t enough dollars in circulation to catch up to the compounding interest of the debt. It’s not a “zero sum” game – in fact debtors are at a distinct disadvantage, because they’re always chasing increasingly scarce dollars with which to pay off the (exponentially increasing) debt. The greater the overall debt, the bigger this chasm.

        The law of exponents dictates that a debt-based fiat monetary system is unsustainable.

    2. Glen

      Just wait – the Feds will soon off the 30 year C Bills (Coffee cans) for $100 filled with the smokes, TP, and ammo of your choice in a coffee can suitable for 30 years buried in the back yard.

      Each $100 you spend will be used by Jamie Dimon or Lyod Blankfien to light one at least one cigar!

    3. jake chase

      The Fed doesn’t seem to understand that the slump is caused by its determined support of real estate prices which remain far too high. Real estate is 10% of “normal” US economic activity. Maintaining fictional housing values eliminates construction employment and inevitably produces a slump, unless government provides work, either on infrastructure or leaf raking or war making. The idea that “entrepreneurship” can be “energized” by low interest rates is a fantasy which Keynes exploded seventy-four years ago.

      As for inflation, businesses raise prices whenever they can. It is only competition which keeps prices stable. You won’t get inflation without a war which eliminates excess capacity. All these people buying gold may soon find themselves revisiting 1981.

      Debt which cannot be repaid will not be repaid. Sooner or later the debt must be written off, after which real activity will restart. We have reached the limit of extend and pretend.

      Meanwhile, finance continues recapitalizing existing assets, industries consolidate, fat cats fatten, job seekers suffer and the middle class watches its savings trickle away, impoverished by a predatory monetary policy.

      Only politics can begin to solve the problem, and our politics is gamed by determined exploitation of a public brainwashed by relentless media idiocy. Expect more of the same. There are no solutions because those in positions of power (and those hoping and scheming to gain power) are all doing very nicely with things as they are and fully committed to continue the process for as long as they keep drawing emoluments and rewards. FDR is dead and he isn’t coming back. Moreover, only WWII saved his economic reputation, which was built on the same kind of determined misdirection now being practiced but with timely assistance from a Europe devoted to wholesale slaughter.

  3. F. Beard

    … of the basic operation of banking, which is maturity transformation (borrowing short and lending long).

    Which is ethically impossible. Thirty (or a hundred or a thousand) 1-year CD’s do not balance one 30-year loan. Thus to borrow short and lend long is gambling. Yet our entire economy is built on that foundation – gambling.

    1. Carla

      Yeah, our whole system is built on gambling AND there is no money.

      It’s a confidence game, and the jig is up when the middle class catches on. The poor already know the consequences, but who listens to them? The rich think they’re insulated. I say they’re only safe as long as the middle class refuses to see the charade.

  4. Matt

    It’s a nothing announcement, and the analysis is flawed by extrapolating the yield curve from long ago to 2011.

    The FRB will earn about 2.5 percent instead of 0.01 percent on 400 Billion and have another 10 Billion a year to pay off the losses in the MBS or give back to the Treasury.

    The effect on 2011 short term rates will be nil, so the comment about little change in average interest rates seems bogus. Its not about the 10 or 30 year interest rates, its about the Bank owned bag man the FRB going long instead of the banks. How much housing stimulus does any one expect to get even if they could lower the 10 year rate another point?

    Any banker or investor with a sense of history knows the fallacy of borring short and lending long, even if it is buying Treasuries. The comment that this will hurt banker’s profits would be better directed at lowering off shore Treasury holders interest payments.

    China rolled from longer to short term Treasuries, maybe this preempts a buyer’s strike.

  5. Slim

    “From an ordinary person’s point of view–Hello, up there, anybody home?–low interest rates are another nail in the savings coffin. I mean, why put money into accounts that don’t even match inflation?”

    That’s the idea buddy… the stock market starts looking pretty attractive sooner or later.

    1. CB

      I’m in the stock market. Pretty much buy and hold. Mutual funds. It does not look attractive, but I don’t shuffle money around at every twitch and sneeze in the market. At any rate, there’s not enough money there to make me a player.

      I’m well aware of the “force them into the market” theory. Considering how little money ordinary people have, you’d have to be living in the alternate universe of wealth or deluded to think ordinary people have enough to put into the stock market. Or maybe you were kidding? I don’t know that the market in it’s current state is any place for genuine investors, at all. Especially small money investors.

        1. CB

          Never worked with a 401(k) or any pension plan. The money I put in was out of checking account, and that’s the money I’m talking about. How are those 401(k)s working these days? For someone young enough, it may eventually end well. For older workers, I’m dubious.

          Ignore the copy at the bottom. I must not have clicked Reply.

      1. chris

        You could try precious metals but always buy the F’ing dips.

        The Asians are buying, the Indians are buying, even Europeans who did not flee their money to Swiss banks are buying.

        Of course, please feel free to put your faith in paper backed by nothing and printable/digitally conjured in the trillions backed by insolvent nations.

        1. F. Beard

          Fiat is backed by the fact that taxes are required in it. As for PMs, any value beyond their commodity value is bound to be in a bubble, UNLESS they are remonetized by GOVERNMENT FIAT (intentional irony).

          1. CB

            And then there’s the various fees problem. For buying and storing, that is. No, I’m not buying gold bars, thanx. Some cultures have other means of buying into PM, jewelery, for instance, which is probably how small money buyers in those countries can afford the freight, as it were. I read a very interesting article about gold buying in India supporting a high floor under gold prices for the foreseeable future because India’s thriving economy is distributing more and more disposable income to more and more people. But that also means that Indians dispose of disposable income in gold purchases way beyond what Americans do: that’s a belief system supporting a market solution.

      2. aet

        Fine arts and wines; but one must first have taste to invest wisely in those, and sadly, taste itself is something that can’t be bought.

        If in fact you do have taste, or are even simply conceited enough to think that you do, you should buy what gives you pleasure with your “excess-to-present-needs” funds. Nobody lives forever; and if durable, and if you really do have taste, the object will inevitably increase in value should you decide to sell in the future.

        Such spending might even give some artisan employment for her otherwise unmarketable skills.

  6. Tertium Squid

    “this reduces the profitability of the basic operation of banking, which is maturity transformation (borrowing short and lending long).”

    Wow – are there any banks out there that still do that? I thought they were all equity casinos right now.

    1. Matt

      The Banks have north of 1 Trillion in excess deposits at the FRB earning 0.25 percent. If the Banks wanted to hold more long term Treasuries, they could have bought them with those dollars.
      The banks have exactly as much long term Treasury exposure as they want.
      One of biggest Bank failures in the US occurred when a bank over bought long term Treasuries and then short term rates rose.

      1. chris

        The banks also have at least that much in assets/loans that are not valued at real world prices. And since

        Assets less liabilities equals owners equity (capital)

        overstating assets means that capital is not as advertised=banks are undercapitalized bordering on or actually insolvent.

        Your results may, always read the owners manual.

  7. Ron

    “For me, the most significant development from the Fed’s announcement is a change in policy where the Fed will re-invest proceeds of maturing MBS securities in new issues of Agency MBS paper. Prior to today, the Fed re-invested principal repayments in Treasury bonds.
    I wrote about the possibility of a mega mortgage ReFi by Fannie and Freddie (here and here). I (and many readers) pointed to an obvious flaw in the ReFi story. If a Trillion or so of mortgages were rapidly prepaid, then who would buy all of the new (much lower coupon) mortgage paper?
    Now we have the answer. The Fed will put the new MBS paper back on its Balance Sheet, $ for $. There will still be many bondholders outside of the Fed who will get prepaid much faster than they had assumed. Most of that is in pension/bond funds. No one cares about them.”

    Bruce Krasting: WH and Fed sleeping together

  8. Paul Tioxon

    I am not sure entirely what M. Auerbach’s full line of argumentation consists of in pointing out that a quantity as a target does not tell us what result in in interest rates or employment they are attempting, or any other result. That is the main point you highlight and it certainly makes sense. What ever results are anticipated, it is my hope that repairing the economy by allowing lending to increase for business expansion, and thereby job creation is the goal. Only if you assume that the economy is a mechanism of market activity, and will rationally respond to the incentive to borrow in order to buy a house, refi a mortgage or other loan or take out new debt for a car, etc., in addition to hoped for business expansion on the supply side of the universe.

    Increased demand as well as more job creation from new enterprise or expansion should result from these incentives of loose fed policies.

    But there is a variable to the equation that Speaker of the House Boehner enunciated out loud. Apparently the stimulus response mechanism model does not work in the face of organized political opposition in the form of Capital On Strike. If job creators do not want to re invest their own surplus cash, why would they want to go into debt? Even at low rates, even with other peoples money, when they have no intention of expansion, creating jobs, and thereby making Obama and the Democrats look good enough to re elect.

    From the text of Boehner’s speech 9/15/2011 at the Economic Club of Wash DC: “I can tell you the American people — private-sector job creators in particular — are rattled by what they’ve seen out of this town over the last few years.

    “My worry is that for American job creators, all the uncertainty is turning to fear that this toxic environment for job creation is a permanent state.

    “Job creators in America are essentially on strike.”

    From the Huff Post article, Prof McElvaine reminds us that FDR made exactly the same claim, but from the point of view that the his policies were under attack by the capital strike. The chances of economic recovery are thwarted by the organized political opposition, blunting the business ass usual response. If Bernanke is such a Depression Era scholar, he must be aware of the political dimension of policy implementation. Policy, is the intersection of raw power in politics with business interests. Decisions are made with a different calculus, and targeting a quantity, without stating a policy goal, is sound and maybe not fury, but still, signifying nothing.

    1. Procopius

      Not exactly on-topic: It seems to me that if Bernanke claims to be a student of the Great Depression, much of what he wrote and recommended is stuff he does not actually believe in. If we assume that what he does shows what he believes in better than what he says (a rule of thumb I’ve always liked) it seems inescapable.

    1. LucyLulu

      I didn’t read the lawsuit so its not clear exactly what damages they are pursuing, however Texas statutes do not require that deeds be recorded when title is transferred. Therefore attempts to seek claims for the recording fees that MERS avoided would, IMO, be a difficult case to make.
      Disclaimer: I am not an attorney, or Yves.

  9. Ray Phenicie

    From the Bernanke generated statement:
    ” To help support conditions in mortgage markets,the Committee will now reinvest principal paymentsfrom its holdings of agency debt and agencymortgage-backed securities in agency mortgage-backedsecurities. In addition, the Committee will maintainits existing policy of rolling over maturingTreasury securities at auction”
    ? (scooby doo moment)Owwer?
    Those wonderful mortgage backed securities are going to be our salvation?
    Those sleeszy, trashy, garbage filled, left over pieces of what-should-have-been-a-fire-sale pieces of junk?
    The very same fraud that brought us down to our knees economically is now to be our salvation?

    1. Dan G

      I read that article. Lets see if the whitehouse announces a “mega” refi program as Bruce suggests. The amount of rollover MBS would not qualify as enough proceeds to perform a mega refinancing plan. It would necessitate a QE for RE or QERE which would get pushback considereing the FED is not supposed to be in that business.

  10. Because

    Sorry guys, your missing the real point: the banks bad contracts are expiring. While the banks loaded with toxic assets are screwed, the ones that aren’t have become 100% solvent again.

    This means debt writedowns, foreclosures and liquidations will commence at a speedy rate. By this time next year in real estate, we will likely have seen a big spike in home sales, big decrease in prices and a surge of new home construction by the 2nd half of 2012(though it will still be far below past trends). I also suspect 1-2 major banks will have failed. Those contracts expiring are what the bailout was for in the first place as the counterparties would have destroyed the economy. Now, the economy will get a boost from the liquidations………from a lower level. Then you still have the corrupt system still in place. We will have another “naughties” mess soon enough, but probably from a different angle.

    Operation “twist” is about pushing this along. QE was about bringing it to the forefront(which it failed to do). Asset disinflation has begun.

    1. chris

      I don’t think so …… Which banks are you referring to that have no toxic assets left?
      you mean B of A , Wells , Bank of NY
      JP Morgan Chase? Citi?
      And you still have the issue that all the loans from Country Wide now at B of A might be up for challenge as to whether they complied with the PSA. The banks have tried to speed up the process already and they were exposed for their fraudulent activity. Unless their are sweeping changes in the Laws across the country, which could happen, the process will be slow and the 3 years wasted already will be just the beginning.

  11. Joel

    What’s with all the naysaying? The twist worked awesomely back in the Kennedy administration so definitely let’s try it again. Unfortunately the Kennedys soon had bigger things to worry about so the twist never got the great credit it deserved.

    Seriously though, it didn’t do squat back then and the Fed gave up on it pretty quickly.

  12. Jim Haygood

    What El Bernanko has done with his deranged caper is to buy the exact freaking top of a thirty-year secular bull market in bonds.

    Leveraged more than fifty-to-one, the Fed is guaran-damn-teed to slide into insolvency when long rates rise … as they soon and surely will do.

    Like self-respecting pederasts who would never stoop to the desperate expedient of humping sheep, three fedguvs dissented from Bernanke’s unapologetic swerve into grand-scale public indecency.

    But it wasn’t enough. Bensane Bernanke — the man who broke the Federal Reserve — has donned his pink-and-turquoise-striped, pointy-headed dunce cap … as the Fed’s Greatest Fool.

    Worship him … or lynch him.

    1. Eagle

      Speaking of the “Bensane”, care to put your credibility on a more exact timeframe around how “soon” the Fed slides into insolvency (or requires a bailout from Congress/Treasury)?

  13. Maximilien

    “I am beginning to believe there is some concerted effort on foot to utilize the stock market as a method of discrediting my Administration. Every time an Administration official gives out an optimistic statement about business conditions, the market immediately drops.”
    —–Herbert Hoover

    Poor ol’ Ben must feeling a little paranoid himself today. Markets were trading flat, he announces a new strategy, and they nosedive.

  14. CB

    Never worked with a 401(k) or any pension plan. The money I put in was out of checking account, and that’s the money I’m talking about. How are those 401(k)s working these days? For someone young enough, it may eventually end well. For older workers, I’m dubious.

  15. Hugh

    To be honest, I haven’t any idea what the purpose of these new Fed programs is. The short for long Treasuries swap out will depress bank profitability but is unlikely to increase business borrowing in the face of slack demand. It’s not clear that those who take the swaps won’t just roll that money back into Treasuries again. I mean one of the reasons they put their money in Treasuries was probably safety in the first place.

    As for the ABS buy ups, this looks like an extend and pretend exercise. The Fed takes on agency dreck. To me, this looks like a transfer of down the road losses from Fannie and Freddie to the Fed. The banks might have a piece of this but I don’t know how much would come to. I rather think it would be far less than what Wall Street needs to keep the casino going. It would however give the banks some cover to continue their mark to myth valuations on their own crap.

    Keeping the Fed rate near zero into 2013 is an admission that the economy is going to suck for something like the next 2 years. I don’t think ZIRP by itself is capable of keeping the casino juiced. It’s a useful tool to goose markets and fleece slow movers but without fresh blood to sucker in its utility is severely reduced.

  16. Michael Haltman

    What s the difference between Tropical Storm Ophelia and the Feds Operation Twist?

    One is projected to do no harm to the United States while one most likely will!

    Mike Haltman
    The Political Commentator
    “Tropical Storm Ophelia and Fed Operation Twist: Which will be more damaging to the US?”

  17. ep3

    “which is maturity transformation (borrowing short and lending long)”

    won’t this destroy CD rates and other low risk investments? If this move destroys this function of banking, what does it do to the new normal function of banking (gambling)?

Comments are closed.