WSJ has a detailed report about the inner thinking of various Fed members, here.
Bottom line: The deliberating body of the Federal Reserve doesn't have a clue. It does not appear most of the members understand how Bernanke's new "tools" work. It does not appear that most members understand the difference between low interest rates and Fed money printing. Further, the confusion is multiple and from many different directions.
But what really caught my eye in the WSJ report was this snippet:
Before the meeting, officials at the Federal Reserve Bank of New York, which manages the Fed's portfolio, had grown concerned, according to people familiar with the matter. The Fed's portfolio of mortgage-backed securities was about to begin shrinking much more rapidly than anticipated, as low mortgage rates led more Americans to refinance their mortgages. That in turn meant the mortgage-backed securities held by the Fed were being paid off.These are the kinds of surprises you are going to get with Bernanke's new, untested for any length of time, "tools."
The size of the Fed's portfolio has become one of the central bank's major monetary tools. A shrinking portfolio in the face of slowing economic growth was unwelcome to many officials, including New York Fed President William Dudley. It amounted to prematurely applying the brakes.
The New York Fed's markets chief, Brian Sack, had been revising up his estimates of how much the portfolio would contract. In a memo circulated by Mr. Sack's group a few days before the meeting, the estimate was revised up again. In March, the group projected the portfolio would contract by a bit more than $200 billion by the end of 2011. In a memo circulated by Mr. Sack's group a few days before the meeting, the estimate was revised to up to $340 billion. In addition, about $55 billion in debt issued by the mortgage giants Fannie Mae and Freddie Mac that the Fed held would likely be paid off. Taken together, it represented a potential 20% drop in the Fed's holdings in 18 months' time
They really are having trouble gauging how much cash is going to flow at them from their MBS "investments." This should not be a surprise. I recently wrote:
The Fed just announced their purchases for this month. It will be $18 billion.
To recap at this point: Krugman is way off and doesn't know what is going on. He wants the Fed to go nuclear. Cowen doesn't appear to understand that there is complexity. B of A analyst is looking at the right numbers but appears to be off by about 50%. And EPJ's own Bob English gets almost a direct hit with his calculation of $14.7 billion.
This shows you how complex things get with Bernanke's new tools. But there's much more.
The monthly estimates only hold under current conditions. As English puts it:
If interest rates were to stay constant (which of course they won't), this would equate to $170.9 billion. If interest rates continue to go down, the amount increases, if they rise, the amount decreases. Also, if Freddie and Fannie started realizing losses and paid off defaulted securities, this number could explode.
Got that? Although cash flow estimates of Fed reinvestments are based on current interest rates. If rates go up or down, the cash flow will vary.
And if Freddie and Fannie start realizing losses and pay off defaulted securities, you don't want to know what's going to happen. The numbers will explode.What this all means is that the Fed is using a "tool" where it is unclear of its impact. By making a decision to reinvest cash flow from MBS investments, the Fed has chosen to use a tool where the amount of new money created is not known. How's that for away to "control" the country's money supply. This is insane, even by standards of those who would like to inflate money. It means there is no set amount the Fed is going to reinvest. It all depends on what comes flying at the Fed.
Further, it remains totally unclear as to the multiplier effect of the reinvested money. Will money supply multiply, at the M2 level, by a factor on 1 or 10 or somewhere in between? If Bernanke weren't so delusional, I would think he would be having a nervous breakdown right now.
Buckle your seat belts. This is going to be a very, very wild ride. And make sure you hold long-term gold. This is likely to end with huge inflation.
Poor Brian. He's probably the best thumb on the monetary pulse the Fed has, and he's getting it wrong by orders of magnitude.
ReplyDelete[EPJ: Best Fed-watching site indeed.]
'The Fed has chosen to use a tool where the amount of new money created is not known.'
ReplyDeleteThin-air money was created when the MBS were purchased. Reinvesting MBS principal payments into Treasuries doesn't change the amount of the Fed's securities portfolio, just its composition.
The real issue is that the new $2.05 trillion floor on the Fed's holdings freezes QE I in place, probably forever -- voiding promises that it would be withdrawn when the economy returned to normal.
Reducing the Fed's holdings at any time in the future will deleverage the system, just as it did this summer.
The Fed is buying Treasuries from the primary dealers in this QELite, just like QE1. It adds back to the excess reserves held at the Fed, but won't add to the money supply. Sterilized. Unless Ben starts to charge fees on the excess reserves (i.e. negative interest, like Sweden did), banks will continue to hold them at the Fed, like they have done.
ReplyDelete