from today's NY Times
Fed Move on Debt Signals Concern About Economy
Mary F. Calvert for The New York Times
Ben S. Bernanke, the Federal Reserve chairman, and other officials believe that the Fed has the ability to avoid deflation.
By SEWELL CHAN
Published: August 10, 2010
WASHINGTON — Federal Reserve officials, acknowledging that their confidence in the recovery had dimmed, moved again on Tuesday to keep interest rates low and encourage economic growth. They also signaled that more aggressive measures could follow if the job market and other indicators continued to weaken.
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With short-term interest rates already close to zero, the Fed’s policy makers have relatively few tools available to encourage consumer and corporate spending. So they now plan to use the proceeds from the Fed’s huge mortgage-bond portfolio to buy long-term government debt.
That action may put downward pressure on long-term interest rates and stimulate borrowing. For consumers, it means mortgage rates are likely to remain at record lows for some time.
Though the immediate impact is likely to be modest, the decision is a turnabout from only a few months ago, when officials were discussing when and how to begin to raise interest rates and gradually shrink the $2.3 trillion balance sheet amassed through the Fed’s response to the 2008 financial crisis.
In buying at least $10 billion a month in new Treasury securities — a small fraction of the roughly $700 billion in Treasury debt the Fed holds — the central bank is trying to help keep money readily available in the financial markets.
With Congress seemingly unable to agree on substantial new stimulus spending, the Fed could face a far tougher decision later this year: whether to take more drastic steps to pump money into the economy and make credit even cheaper.
“We’re in a lousy middle between the economy picking up on its own and falling off a cliff,” said Cathy E. Minehan, a former president of the Federal Reserve Bank of Boston. “And that makes policy-setting really hard.”
The announcement on Tuesday, after the scheduled meeting of the Fed committee that sets interest rates and monetary policy, confirmed what had been widely discussed among economists and business leaders in recent days: the Fed would move more decisively if the economic picture darkened.
The Fed, led by Ben S. Bernanke, its chairman, has shifted away from its more optimistic outlook earlier this year. “The pace of recovery in output and employment has slowed in recent months,” said the Federal Open Market Committee. The statement added that the nation’s economic recovery was “likely to be more modest in the near term than had been anticipated.”
Yields on 10-year Treasury securities, a benchmark for home mortgages and corporate loans, tumbled to their lowest level in more than a year on Tuesday. Rates on 30-year Treasuries briefly fell below 4 percent. The yield on a 10-year Treasury note dipped to 2.765 percent from 2.83 before the announcement.
Stocks regained some of their losses from earlier in the day. At its close, the Dow Jones industrial average was down 54.5 points, or 0.51 percent, to 10,644.25.
From January 2009 to March 2010, the Fed bought $1.25 trillion in mortgage-backed securities and about $175 billion in debt owed by government agencies, primarily the housing finance entities Fannie Mae and Freddie Mac. The Fed had planned to allow the size of that portfolio to shrink gradually as the securities matured or the debts were prepaid.
Instead, the Fed will now reinvest those principal payments in longer-term Treasury securities. (The central bank said it would continue to roll over its holdings of other Treasury securities as they mature.)
The money involved is unclear. In March, the Federal Reserve Bank of New York estimated that at least $200 billion of the mortgage-related securities and debt would mature or be prepaid by the end of 2011.
But mortgage rates have dropped since then, giving borrowers an incentive to refinance and pay off existing mortgages, so the actual figure could be substantially larger.
By not allowing its debt holdings to decline below the level of $2.054 trillion at which they stood on Aug. 4, the Fed is preventing what economists have called the passive tightening of monetary policy. The Fed still has the option, if conditions warrant, of increasing its debt purchases.
Some analysts believe that if the economy worsens, the Fed might begin a new round of quantitative easing — the strategy of buying financial assets to increase the money supply.
In its statement, the committee said that while household spending was gradually increasing, high unemployment, modest income growth, a drop in household wealth and tight credit continued to hamper growth.
The committee said it still expected a “gradual return” to normal economic conditions, although the recovery was less robust than expected at this point.
Ethan S. Harris, an economist at Bank of America, said he was “mildly surprised” by the Fed’s action — “not that they did it but rather how quickly they decided.” He added, “My expectation had been that the Fed would take a little more time to switch gears and prep the market.”
The decision not to let the balance sheet shrink was a relatively easy one, Mr. Harris added. “To go back to big asset purchases is a much bigger step, and it would require clear signs that the economy is heading toward a double-dip recession.”
Economists who work in the markets had a mix of reactions.
Bruce McCain, the chief investment strategist at Key Private Bank, said the Fed “steered the middle ground.”
“Given the uncertainty, hopefully the middle ground calms nerves and keeps people confident enough to go ahead and spend the money that they have in productive ways,” he added.
But a former New York Fed economist, John Ryding of RDQ Economics, said the announcement suggested “a bit of a feeling of panic by the Fed.” And Joshua Shapiro, an economist at MFR Inc., said the Fed’s announcement “appears to mainly be designed to provide itself with political cover against a backdrop of a gut-wrenching economic correction that shows no sign of ending anytime soon.”
Along with additional quantitative easing, another option available to the Fed is to lower the interest rate (now 0.25 percent) it pays on the roughly $1 trillion in reserves that banks hold at the Fed.
While that action could be helpful, it carries some risk, said Christopher L. House, an economics professor at the University of Michigan.
“If they were to simultaneously lower the rate to zero while leaving $1 trillion in reserves in the banking system, they would have a lot of reason to worry about inflation,” he said.
In its announcement, the Fed also left unchanged its benchmark short-term interest rate — the federal funds rate, the rate at which banks borrow from one another overnight — at zero to 0.25 percent, its level since December 2008. And it maintained that the rate would remain “exceptionally low” for “an extended period,” the language it has been using since March 2009.
The Federal Open Market Committee’s vote on Tuesday was 9 to 1. The dissenter was Thomas M. Hoenig, president of the Federal Reserve Bank of Kansas City.
Mr. Hoenig, who is known for his focus on inflation, the Fed’s traditional enemy, dissented for the fifth consecutive meeting, both on the extended-period language and on the decision to reinvest the mortgage-bond proceeds.
Christine Hauser contributed reporting from New York.
A version of this article appeared in print on August 11, 2010, on page A1 of the New York edition.
Great story and great you, Thanks. John
I love it. Makes me want to jump into the magic of my growing up with my small town bookie father, Big Johnny Raff, and my wonderful mother Beatrice (Bea Happy) Pratt Rafanello, and my Will Rogers wisdom toting Grandpa Plenny Pratt, and on and on, first as an only child with my American flier trains, erector sets, and my jobs - fixing radio's and TV's for Pop's gambling clients, cutting grass using pop's gas and lawnmower and "forgetting" to cut our grass. The Saturday afternoon cliff hanger serial movies at the Carberry theater. Pop and Sachmo playing craps in the living room with a bunch of other stogy cigar smoking Italians, and on and on. Thanks for the memories. I can hardly wait to write "The Johnny Raff Chronicles" The Early Years. love John
Thank you for your answers to my questions.
I have also decided to only read and respond to the replies that make me feel good. I know it’s a selfish attitude, but as I only want to feel good, I have decided to do it anyway.
As always, I wish you all that you wish for yourself.
Love, John
You da man, Ted!