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It’s official: the Fed is monetizing government debt

On November 2, I wrote an article about the new-found relationship between the Fed and the Treasury. Here is a bit from the article:

The Treasury is sterilizing the Fed’s liquidity measures, rather than the Fed monetizing the Treasury’s debt (just add this to a long list of unprecedented acts by the Fed and the Treasury). … At some point the Fed may choose to monetize new debt issued by the Treasury (let’s say in order to raise $700 billion to finance TARP), but I doubt it. There is already a new $1 trillion of new liquidity sloshing around in the banking system, posing huge inflationary risks. Well, circumstances have changed. Twenty-four days later, and in a rather nontraditional manner, the Fed is now monetizing government debt.

The time has come to officially monetize government debt. Yesterday the Fed announced that it would purchase $100 billion in debt obligations from Fannie Mae, Freddie Mac and the Federal Home Loan Bank next week. And furthermore, it will purchase $500 billion in mortgage-backed securities (MBS) – I like to call this FARP (Fed Asset Relief Program).

The purchase of GSE debt is a direct attempt to reduce the spread on government agency (GSE) debt over comparable Treasury debt, the relative borrowing costs. Basically, the Fed is targeting a lower interest rate on GSE debt. Sound familiar? Yup, that’s monetizing government debt.

fannie_debt_chart.png

The chart illustrates the difference between newly issued Fannie Mae debt and a comparable U.S. Treasury through 11/24/08. This spread has widened from an average of 29 bps (0.29%) spanning 2006-2007 to 90 bps spanning 2007-2008. Fannie Mae must pay more in order to finance its mortgage obligations, which limits its ability to roll over current obligations, and tightens the terms on new mortgage loans.

By driving down the spreads on GSE debt now, and later on mortgage-backed securities, the Fed gives the GSEs more flexibility in the mortgage market, and they can offer lower rates and better terms for potential homebuyers. That’s the theory.

I am interested to hear why the Fed is supporting the GSE debt and securitized assets that derive their value from the mortgages (MBS) rather than the mortgages themselves. The Fed could allocate a similar stock of resources to mortgages directly, where the effect would be immediate (mitigating foreclosures or offering better terms directly). However, I assume that the Federal Reserve Act prevents the Fed from doing such a thing – that sort of action probably lies in the hands of Congress.

Expect the Fed’s balance sheet to rise by another $100 billion (at least) in two weeks. It is official: the Fed is monetizing government debt.


Originally published at the News N Economics blog and reproduced here with the author’s permission.

9 Responses to “It’s official: the Fed is monetizing government debt”

John RyskampNovember 27th, 2008 at 12:55 pm

I am interested to hear why the Fed is supporting the GSE debt and securitized assets that derive their value from the mortgages (MBS) rather than the mortgages themselves. The Fed could allocate a similar stock of resources to mortgages directly, where the effect would be immediate (mitigating foreclosures or offering better terms directly). However, I assume that the Federal Reserve Act prevents the Fed from doing such a thing – that sort of action probably lies in the hands of Congress.The reason is, to be consistent with its policy of bailing out bonds, rather than assets. That’s why all of this will get absolutely nowhere (except to collapse the dollar).It is also the modernized version of Mellon’s “liquidate liquidate liquidate.” All economic power is returning to Washington–it is “circling the wagons.” Which means that there will be 0–that’s right, 0–economic activity.Washington is no longer bouncing the money ball out of Washington, hoping that it will bounce around the country. That’s over. Now it’s bouncing the money ball WITHIN Washington.You, and Nouriel, and LOT of other people, because you are ignorant of American law, base your analyses on massive Federal intervention in the economy during the last 70 years, since it was allowed to set up the “scrutiny regim” in West Coast Hotel v. Parrish (1937). The political system immediately took this case to stand for the proposition that, as long as government policy was to intervene in the economy, then it was Constitutional for the political system to have nearly absolute power over nearly all facts.That is your mistake. NOWHERE was there any concession of the idea that, when the political system decides to defend its OWN existence over the economy’s existence (“liquidate liquidate liquidate”), somehow the Constitution prevents it from doing so.In short, you have misanalyzed all the Federal intervention in the economy. It never was done in order to support the economy. It was always done in ordr to strengthen the political system.This is why it has been a lie/misanalysis to say that Federal efforts so far have been made in order to “stabilize the finanical system.” They haven’t done so, it was never their point to do so. The point of these interventions was a “circle the wagons” effort: they were done in order to strengthen the political system.What you are saying is that the Federal government is now liquidating. What you point to, is simply the (insane) logical conclusion of the Federal policy to “retreat” to a strengthening of the political system at the expense of the society. But that has ALWAYS been bedrock Federal policy.You have grown up with the myth that somehow the Federal Government=the economy=the society. You better grow up fast. This has never been the case.The way OUT of this mess is to read the term “maintenance” in West Coast Hotel, and understand that it does NOT stand for the “liquidationist” scrutiny regime, which says that law is rationally related to a legitimate government purpose. Instead, it stands for the proposition that law maintains important facts. Housing is an important fact. That leads to what the Federal SHOULD do now, and what I have been advocating on this site for two years now:BAN HOUSING EVICTIONS.I write all about this in my book The Eminent Domain Revlt.You will note that “monetizing Federal debt” is at the furthest remove from banning housing evictions. This is the measure of the suicidal nature of Federal policy.Because, of course, circling the wagons never works. This will be realized once unemployment goes to 30%, which it will.By the way, your boss Nouriel has been so wrong, both in his underlying premises and his specific predictions, that he doesn’t have much credibility any more, and had better revisit his fundamental ideas.He said that the worse this crisis would get would be flat to -1% GDP. What a ridiculous joke. We are rapidly heading about 15%. He said the stock market would be closed. Hasn’t happened yet!He’s far gone in elitist madness himself. Very ignorant and vain. Go in the other direction from this megalomania.

KiersNovember 27th, 2008 at 6:59 pm

You know, this is just step one. “Monetizing the Gov’ts debt” is just the same as buying outstanding obligations. Flooding the public with CASH.Apparently this (monetizing) was necessary because of a “liquidity crunch”. However, given a slight change in termiinology: This could also be seen as a “LOSS OF CONFIDENCE” in the “Government’s” (Quasi) Debt (in the first place)!…Oh My God!In this loss of confidence, step 2 is the loss in confidence of the dollar itself. Then we’re all toast, except for our country’s stockpiles of weapons and ammo!

samJanuary 14th, 2009 at 9:45 pm

the legislature and the executive branch have one central purpose–they are PAID by the owners of the central bank to create govt programs or activity ie war, that require financing beyond tax receipts–by borrowing from the owners of the federal resrve and the bondholer class in general.the owners of the fed are collecting interest yearly on trillions in national debt–all wealth/power eventually devolving to themthis is the central horror that no one is willing to speak of, even if they understand it.

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