Saturday, June 23, 2012

Is Operation Twist the First Fed Bailout of the U.S. Treasury by the Fed

Since September the Fed has been driving down long-term interest rates via "Operation Twist". OT consists of the Fed selling its shorter-term securities and using the proceeds to buy longer-term ones. This week the Fed decided to extend OT through the end of the year.

The Fed has sold the program as a way to provide low rate financing for businesses and those seeking mortgages, but what institution has taken the most advantage of the program? The U.S. Treasury.

According to WSJ, while the Fed has been snapping long-term bonds off the market, the Treasury has been ramping up its issuance of long-term debt to take advantage of historically low long-term rates. Since October 2008, the average maturity of outstanding marketable Treasurys has climbed by nearly 32%, reaching almost 64 months in May. That’s its highest level in a decade.

Got that? WSJ makes clear what is going on (My bold):
The Fed’s policies, meanwhile, are a boon to the Treasury. By pushing down the cost of borrowing, the Fed has helped the Treasury finance government debt for less.
As far as I'm concerned it's the first bailout of the Treasury. It's not much different in structure from what the European Central Bank has been doing when it buys long term debt of eurozone countries to keep rates lower. This is not to say that Fed buying of Treasury securities isn't always a case of propping up the Fed, but this is intensifying the situation and shows further signs of desperation.

The Treasury in recent years has, for the most part, issued short-term debt. This is extremely dangerous for the Treasury, since an upward move in interest rates would force the Treasury to refinance short-term debt at higher rates--sending the deficit through the roof.

The Fed's operation gives the Treasury the opportunity to shift some of its debt from the short end of the yield curve to the long end, thus relieving some of the short-tern interest rate exposure, it's kind of a pre-crisis mini-bailout of the Treasury by the Fed.

You can see what is going on by these charts.Here is a chart of  U.S. Treasury securities held by the Federal Reserve: Maturing in over 1 year to 5 years. As you can see, it is crashing as the Fed conducts its Operation Twist:

Here is a chart of U.S. Treasury securities held by the Federal Reserve: Maturing in over 10 years. It's soaring, The climb started before OT as the Fed outright bought long term Treasury securities, but has accelerated since OT:

Since August, 2011, short-term securities held by the Fed have declined by 25.8%. Obviously, at some point, the Fed runs out of securities by which to do the Twist. As of June 20, 2012, the Fed had only $532 billion in  Treasury securities with maturities of 1 to 5 years.

The real problem is that  most Treasury debt is still in the form of shorter-term securities. The Treasury expects that by the end of fiscal year 2012, it will have almost 68% of its debt maturing in less than five years, according to a second-quarter 2012 report. Keep in mind that total Federal debt is now over $15 trillion. This means that the Treasury will have to refinance trillions in short-term debt beyond what OT will enable the Treasury to move into long-term securities. The OT program is in other words pocket change and the Fed doesn't have enough of the short-term securities to twist it otherwise. Thus, when interest rates start to climb, as thet ultimately will, the increase costs to the Treasury will be enormous. And that's when the Fed will really go into bailout mode by buying up massive amounts of Treasury securities. . All the Fed money printing that will be required to buy up the Treasury securities will, of course, be highly inflationary for the rest of us and the last thing you will want to own is those Treasury bonds the Fed is propping up at present. Keep in mind what ultimately happened when the Fed propped up the housing market. The bond crash and spike in interest rates will be much worse.


  1. Fantastic post.

  2. This is nothing new. The Banksters have been bailing out the US Treasury since at least 1878.

  3. I recall Bernanke testifying in front of a certain committee that profligate [over-]spending was purely a fiscal phenomenon. A certain Congressman called him out on this and accused the Fed of being complicit by artificially holding long term rates low.

  4. All this still won't keep the fed gov't from self-destructing, as it is now sure to do.

  5. The US and FED are also playing defensively. The central banks are ganging up on the euro countries. This is going to come around to the US. A country is vulnerable with its short term debt. If/when this trend heads this way the FED will reverse OT or will claim that its inventory of short US debt is low. THE FED chairman's response to the question about the FED's involvement in the Euro crash was telling.

  6. Is anyone here in the system still? Nobody in their mind could be in paper still could they? If you're still in this paradigm of paper and derivatives of paper, you deserve what's coming! Period!

  7. The article points out that the treasuries that the Fed holds through OT are "pocket change". It failed to follow up on this point. What's really happening is that the Fed bid up long treasuries using OT at about the same time as European investors have been making a mad rush for the euro exit, right into the arms of our very own treasury, who were happy to sell them yet more of our bonds and notes. So all the Fed is really doing is preventing European investors from getting a fat yield by jumping the euro ship into our long bonds. It's as if the 1% declared "no mercy" for Europeans. Don't laugh, we're next. OTOH, if Europeans buy short term, they're playing right into the Fed's hands by keeping the prices up on the 1 to 5 year securities it's trying to sell.