The FOMC's Plan to Buy $1.1+ Trillion of T-bonds, Mortgage Debt, and "Other Financial Assets"

March 19, 2009

The financial media is a-buzz over the Federal Open Market Committees decision yesterday to buy over a trillion dollars in assets. Here is an example. Another is here.

Let me parse the text of the FOMC's press release.

Information received since the Federal Open Market Committee met in January indicates that the economy continues to contract. Job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending. Weaker sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories and fixed investment. U.S. exports have slumped as a number of major trading partners have also fallen into recession. Although the near-term economic outlook is weak, the Committee anticipates that policy actions to stabilize financial markets and institutions, together with fiscal and monetary stimulus, will contribute to a gradual resumption of sustainable economic growth.

The facts point to a continuing decline in the economy. On the other hand, the Committee anticipates that the decisions of the Committee will slowly restore the economy. This is reassuring. Think of what the Committee would have had to say if the Committee believed that it was the decisions of the Committee, 2000 to 2007, that got us into this mess.

In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued.

Subdued. I like that. It conveys an image of a guy in a straight-jacket who is on Valium.

Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.

Here it is, folks: inflation fosters economic growth. We just don't have enough inflation. The Committee will remedy that!

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability.

Got that? We need more inflation in order to promote price stability. You read it here first!

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

The Committee will maintain a rate that says that capital is a zero-price resource. Scarcity has been repealed "for an extended period of time."

To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve's balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion.

There will be an additional $750 billion in the monetary base, meaning high-powered money. This will support the housing market. We wouldn't want affordable housing. The job of the Federal Reserve System is to keep housing prices higher than the free market would maintain. This policy is consistent with the present policy of increasing inflation in order to attain price stability.

Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.

The Interest rate on 10-year T-bonds was 2.5% yesterday. This is the longest maturity in the plan. This rate is above 0%, the rate for federal funds -- overnight loans, bank to bank. The Treasury would prefer T-bond rates closer to 0%. So, the FOMC will add an additional $300 billion in high-powered money to achieve this.

The Federal Reserve has launched the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses and anticipates that the range of eligible collateral for this facility is likely to be expanded to include other financial assets.

The FOMC will extend credit -- more high-powered money -- with collateral based on "other financial assets." What might these be? And how much money will be involved? Silence.

The Committee will continue to carefully monitor the size and composition of the Federal Reserve's balance sheet in light of evolving financial and economic developments.

The Committee will monitor what the Committee is buying. This is good. What if the Committee did not monitor what the Committee is buying?

Developments are evolving. Developments have a tendency to do this.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.

Unanimous!