Fed sets goal for exiting housing finance

Aim is to hold only US govt securities in its portfolio

Federal Reserve officials set a long-term goal to keep only US government securities in their portfolio as they debated how and when to pull back on the most aggressive monetary policy in US history.

Central bankers are planning to eventually remove US$1.43 trillion of housing debt from the balance sheet after critics such as Stanford University economist John Taylor accused them of straying beyond monetary policy. Philadelphia Fed President Charles Plosser said on Wednesday that the Fed’s purchases of housing debt expose it to demands from politicians to support other industries.

Some of the Fed’s emergency actions ‘blurred the line between monetary policy and fiscal policy, thereby increasing the risk to the Fed’s independence,’ Mr Plosser said in a speech. ‘These policies have veered toward deciding how public money should be allocated across firms and sectors of the economy.’

Policy makers agreed that it ‘will eventually be appropriate’ to ‘return to holding only securities issued by the US Treasury,’ according to minutes of their Jan 26-27 meeting released on Wednesday.

‘They are putting down a marker, as much as a signal to the administration as anything else, that they don’t want to be in the credit-allocation game,’ said Dino Kos, managing director at Portales Partners LLC in New York and former executive vice president at the New York Fed.

US central bankers are channelling credit to housing markets through purchases of US$1.25 trillion in mortgage-backed securities and US$175 billion in housing agency debt. Those programmes end next month. Chairman Ben S Bernanke has said the purchases are needed to support housing markets, whose collapse triggered the worst crisis since the Great Depression.

Fed officials in their January meeting also agreed that it would ’soon be appropriate’ to raise the discount rate, at which banks borrow directly from the central bank, and reduce the maturity of the loans to overnight from 28 days.

The Fed’s actions to combat the financial crisis have created scrutiny of the central bank in Congress, which is taking up the most extensive rewrite of financial regulation since the 1930s.

The House voted on Dec 11 to approve a proposal by Representative Ron Paul, a Republican from Texas, to end a ban on audits of monetary policy over Mr Bernanke’s warnings the measure threatens to compromise Fed independence.

The Fed typically uses the purchase and sale of Treasury securities to change the benchmark federal funds rate by making bank reserves less or more available. At the start of 2007, the central bank’s securities portfolio was made up of mostly Treasuries.

Allocating Credit Before the crisis, the Fed avoided allocating credit to specific markets. In a study of open-market operations published in 2002, the central bank’s staff warned about changing the composition of the Fed’s portfolio.

The mission of the Fed ‘is statutorily cast in terms of macroeconomic outcomes,’ the document said. ‘Outcomes for specific sectors and for relative prices of credit or assets are within the purview of private markets and fiscal policy.’ A return to a policy of holding only Treasury securities, even if it’s a goal for now, indicates Mr Bernanke is seeking to assure investors the Fed is committed to independence and to its mandate to maintain stable prices and full employment, former officials said.

‘What the Fed is doing is showing markets a rope,’ said Vincent Reinhart, a resident scholar at the American Enterprise Institute in Washington and the former director of Monetary Affairs at the Fed’s Board of Governors. ‘They are trying to provide a safe port and show the Federal Reserve will always do what is right and has a long-run strategy.’

Fed officials closed four emergency lending programmes this month and are now considering the timing and use of several tools to remove or neutralise more than US$1 trillion in excess reserves from the banking system.

‘Most judged that a future programme of gradual asset sales could be helpful’ to shrink the balance sheet, while some officials were concerned about disrupting financial markets and the economy, the minutes said.

‘Several thought it important to begin a programme of asset sales in the near future,’ including spreading sales ‘over a number of years,’ according to the report.

Source: Business Times, 19 Feb 2010