The Fed Launches “Operation Twist (and Shout)”
The Fed issued a statement Wednesday at the conclusion of its two-day meeting. Maintaining the controversial language from the August statement, the Fed is still focused on keeping interest rates low until at least mid 2013. And as expected, the central bank will keep short-term rates within the target range of 0.0-0.25% . The new development is what’s being called “Operation Twist” (formally known as the Maturity Extension Program and Reinvestment Policy): reinvesting the proceeds from sales of shorter maturity bonds in longer-term securities. For those of you charting the Fed’s actions at home (we know you’re out there) the Fed’s playbook appears to involve first expanding the balance sheet (QEs 1 & 2) then focusing it’s significant purchasing muscle toward that part of the yield curve which offers the biggest bang for the buck. Reducing short maturities and increasing holdings in longer maturities is the twist part—twisting the yield curve into a flatter slope (“flattening the curve”).
This strikes us as a classic “great in theory, lousy in practice” scenario. By buying 10 year Treasury maturities and by reinvesting proceeds from maturing Government Sponsored Enterprise (GSE) debt into GSE mortgage backed securities, the Fed is unabashedly trying to drive mortgage rates even lower. This is the part that makes us want to shout: “Who will benefit from lower mortgage rates apart from the people who already have no problem refinancing?!” We’ve long argued that the problem is not the level of interest rates, but rather the broken transmission mechanism(s) that inhibit the real economy and consumers from benefiting from rates that are already at historic lows. Examples include banking regulations that make lenders cautious and appraisal values that prevent homeowners from refinancing.
What puzzles us most, though, is this: if we’re really serious about incenting the banks to lend—to home owners, businesses, etc.—why is the Fed paying banks 0.25% to keep their $1.6 trillion of excess reserves parked at regional Fed banks? We can’t help but think that at least not paying them almost double the yield of a two-year Treasury to keep excess reserves squirreled away would be the most effective way to get money moving again. And if that didn’t work, why couldn’t we charge banks, say, 0.125% to keep their “mattress money” at the Fed?
In the end, we expect Operation Twist to be about as effective as QE 1 & 2: not very. At least the Fed didn’t announce QE 3 – not yet anyway.
Posted in Current Updates