Minutes of Federal Open Market Committee

[Chris Coles]

Of particular note on page 10:

" In light of the use of additional tools for implementing monetary policy, the Committee revised the form of the directive to the Open Market Desk of the Federal Reserve Bank of New York. In addition to specifying that it now seeks conditions in reserve markets consistent with federal funds trading in a range of 0 to ¼ percent, the Committee instructed the Desk to purchase up to $100 billion in housing-related GSE debt and up to $500 billion in agency-guaranteed MBS by the end of the second quarter of 2009. Members agreed that they should not specify the precise timing of these purchases, but that they should leave discretion to the Desk to intervene depending on market and broader economic conditions. The directive also noted that the Manager of the System Open Market Account and the Secretary of the FOMC would keep the Committee informed of developments regarding the System’s balance sheet that could affect the attainment of the Committee’s statutory objectives. At the conclusion of the discussion, the Committee voted to authorize and direct the Federal Reserve Bank of New York, until it was instructed otherwise, to execute transactions in the System Account in accordance with the following domestic policy directive:

“The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable
growth in output. To further its long-run objectives, the Committee seeks conditions in reserve markets consistent with federal funds trading in a range of 0 to ¼ percent. The Committee directs the Desk to purchase GSE debt and agency-guaranteed MBS during the intermeeting period with the aim of providing support to the mortgage and housing markets. The timing and pace of these purchases should depend on conditions in the markets for such securities and on a broader assessment of conditions in primary mortgage markets and the housing sector. By the end of the second quarter of next year, the Desk is expected to purchase up to $100 billion in housing-related GSE debt and up to $500 billion in agency-guaranteed MBS. The System Open Market Account Manager and the Secretary will keep the Committee informed of ongoing developments regarding the System’s balance sheet that could affect the attainment over time of the Committee’s objectives of maximum employment and price stability.”

http://www.federalreserve.gov/newsev.../20090106a.htm

[phirang]

Re: Minutes of Federal Open Market Committee

Of particular note on page 10:

" In light of the use of additional tools for implementing monetary policy, the Committee revised the form of the directive to the Open Market Desk of the Federal Reserve Bank of New York. In addition to specifying that it now seeks conditions in reserve markets consistent with federal funds trading in a range of 0 to ¼ percent, the Committee instructed the Desk to purchase up to $100 billion in housing-related GSE debt and up to $500 billion in agency-guaranteed MBS by the end of the second quarter of 2009. Members agreed that they should not specify the precise timing of these purchases, but that they should leave discretion to the Desk to intervene depending on market and broader economic conditions. The directive also noted that the Manager of the System Open Market Account and the Secretary of the FOMC would keep the Committee informed of developments regarding the System’s balance sheet that could affect the attainment of the Committee’s statutory objectives. At the conclusion of the discussion, the Committee voted to authorize and direct the Federal Reserve Bank of New York, until it was instructed otherwise, to execute transactions in the System Account in accordance with the following domestic policy directive:

“The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable
growth in output. To further its long-run objectives, the Committee seeks conditions in reserve markets consistent with federal funds trading in a range of 0 to ¼ percent. The Committee directs the Desk to purchase GSE debt and agency-guaranteed MBS during the intermeeting period with the aim of providing support to the mortgage and housing markets. The timing and pace of these purchases should depend on conditions in the markets for such securities and on a broader assessment of conditions in primary mortgage markets and the housing sector. By the end of the second quarter of next year, the Desk is expected to purchase up to $100 billion in housing-related GSE debt and up to $500 billion in agency-guaranteed MBS. The System Open Market Account Manager and the Secretary will keep the Committee informed of ongoing developments regarding the System’s balance sheet that could affect the attainment over time of the Committee’s objectives of maximum employment and price stability.”

http://www.federalreserve.gov/newsev.../20090106a.htm

They write in such a ponderous and pretentious style.

Anyway, i love the price control euphemisims, "price stability" my ass: it's called "we need cheap credit to keep these houses that are fundamentally overvalued - overvalued"

Meanwhile, Foreign CB's aren't buying it... why else is the Fed in agency market, hmm?

[ASH]

Re: Minutes of Federal Open Market Committee

Of particular note on page 10:

Thanks for posting this. It will be an excellent drop-in reference for future posts about monetization.

I wonder if the Fed keeps nominal housing prices "too high" by creating new money to purchase MBS, they can still manage to deflate the real housing price through general price inflation (in the long run). If the Federal Reserve creates $600 B to buy MBS (in this instance) and nominal house prices merely stay flat -- and if the Fed doesn't later mop up those reserves, but rather allows inflation to run high for a bit once the velocity of money comes back up -- then the real housing price can revert to its mean without putting as many home-owners upside down. That converts the social problem into one of reduced living standards spread over a substantial span of time rather than outright and abrupt displacement. Of course, inflation screws bond-holders (and savers and consumers -- most everybody, really), but in this case, the housing bond-holder is the Fed, and absent true hyperinflation, the losses are gradual. If your goal is to allow the real price of assets to revert to their mean without the social dislocations associated with a big fall in nominal prices, then monetization of the underlying debt might just work. If you create inflation in some other way, then the private holders of the debt are likely to dump it, creating a shortage of credit that will adversely affect the market in -- and nominal prices of -- the assets whose deflation you are trying to manage. Since there is a time lag between the increase in the money supply associated with monetization and the onset of inflation, if the Fed buys the debt from private holders in the process of creating the new money, maybe it can avoid fire sale conditions.

Either way, the bond-holders lose -- in a fire sale, they lose their purchasing power all at once in dollars of more-or-less constant value; if they sell to the Fed, the purchasing power of the dollars they get in exchange for the bonds lose value over time to inflation. The same could be said of the public in general: either they lose their standard of living abruptly (by losing their house, or their job, or seeing their assets plunge in value), or they lose it over a span of time to inflation. Still, it's easy to imagine why the gradual path might be prefered by policy-makers.

Not sure this train of thought is entirely valid. Some of it is just what iTulip has been saying all along. Some of it I'm not sure about myself. The argument seems weak to me when one considers the need for credit creation after the initial period of monetization, once the inflation hits. Corrections to my thinking will be gladly accepted.

[metalman]

Re: Minutes of Federal Open Market Committee

The argument seems weak to me when one considers the need for credit creation after the initial period of monetization, once the inflation hits. Corrections to my thinking will be gladly accepted.

whose need? the banks'? the monetization wipes out the debt. the economy runs mostly on cash for a while. later on... new banks arise. ask the argentines... 8 years after their credit collapse the economy still runs on cash... car loans at 20%+... no big deal. nobody dies.

[ASH]

Re: Minutes of Federal Open Market Committee

whose need? the banks'? the monetization wipes out the debt. the economy runs mostly on cash for a while. later on... new banks arise. ask the argentines... 8 years after their credit collapse the economy still runs on cash... car loans at 20%+... no big deal. nobody dies.

Monetization of MBS means that the folks with mortgages are in debt to the Federal Reserve. The Fed could then forgive the debt, but as I understand it, the initial step of monetization itself just means the Fed creates reserves to buy the MBS from banks, funds, and other institutions that hold them. This doesn't wipe-out mortgage debt in and of itself, but leaves the Fed in control of it.

I think the immediate idea is just what phirang said, which is effectively a nominal price control. My understanding is that if the Fed buys enough MBS, it can create demand for the issuance of mortgages -- replacing the private sector demand that helped to fuel the bubble. Since the Fed isn't trying to make money (because hey -- it is making money), the Fed doesn't care about the risk of default that presently deters commercial lenders. If the housing bubble arose partly because mortgage originators were able to securitize mortgages and sell MBS to various investors who badly mispriced the default risk, then the Fed -- being indifferent to risk -- can probably replace some of that demand.

There are two ways in which this might support home prices. The first is simply what the TARP was originally supposed to do -- encourage commercial lending by replacing a liability (illiquid paper that was likely to default) with reserves. To the extent that banks are deterred from lending because they are afraid of the losses they have yet to take on their existing portfolios, this might help. However, to the extent that banks are deterred from lending because there simply aren't any good credit risks to lend to, it is useless. The second way in which this might work is if the Fed started monetizing new MBS. By providing a guaranteed buyer of new MBS, indifferent to default risk, the Fed could make mortgage origination at lower interest rates risk-free and profitable for commercial banks. The availability of mortgages at low interest rates with loose underwriting standards would again allow people who have no business taking out a loan to refinance or purchase nonetheless, and it might arrest the fall in home prices by reducing the foreclosure rate and once again enticing the careless to borrow beyond their means. Of course, this would all be driven by the rapid debasement of the currency, and would come with a time limit. There is also the obvious difficulty that if this is to work, the Fed has to pace things such that it loans money at a low interest rate to consumers to support nominal asset prices, while creating inflation such that the Fed itself is "paid back" in devalued dollars. If wages don't keep pace with inflation (which they probably won't) this wouldn't work too well.

So, I agree that if the Fed monetizes MBS and then has a great big bonfire, that does indeed wipe out the debt. However, if they are simply going for nominal price stability by one of the mechanisms I outlined above, with the intention of bringing real prices to equilibrium through inflation rather than nominal price declines, they will have a need for new credit creation so that people can refinance or take out new mortgages at low interest rates. I think there may be a problem with this nominal price stability scenario because sustained credit creation might be required to keep nominal prices up, and once inflation is felt, the Fed might find it difficult to keep its game going. But maybe it wouldn't need to. Maybe inflation itself would help support nominal asset prices, and replace the need for credit creation for this purpose. I don't know.

[vinoveri]

Re: Minutes of Federal Open Market Committee

Monetization of MBS means that the folks with mortgages are in debt to the Federal Reserve. The Fed could then forgive the debt, but as I understand it, the initial step of monetization itself just means the Fed creates reserves to buy the MBS from banks, funds, and other institutions that hold them. This doesn't wipe-out mortgage debt in and of itself, but leaves the Fed in control of it.
....
...
There are two ways in which this might support home prices. The first is simply what the TARP was originally supposed to do -- encourage commercial lending by replacing a liability (illiquid paper that was likely to default) with reserves. To the extent that banks are deterred from lending because they are afraid of the losses they have yet to take on their existing portfolios, this might help. However, to the extent that banks are deterred from lending because there simply aren't any good credit risks to lend to, it is useless. The second way in which this might work is if the Fed started monetizing new MBS. By providing a guaranteed buyer of new MBS, indifferent to default risk, the Fed could make mortgage origination at lower interest rates risk-free and profitable for commercial banks. The availability of mortgages at low interest rates with loose underwriting standards would again allow people who have no business taking out a loan to refinance or purchase nonetheless, and it might arrest the fall in home prices by reducing the foreclosure rate and once again enticing the careless to borrow beyond their means. Of course, this would all be driven by the rapid debasement of the currency, and would come with a time limit. There is also the obvious difficulty that if this is to work, the Fed has to pace things such that it loans money at a low interest rate to consumers to support nominal asset prices, while creating inflation such that the Fed itself is "paid back" in devalued dollars. If wages don't keep pace with inflation (which they probably won't) this wouldn't work too well.
...

This is pretty much how I see it as well. It's almost too incredible to believe the system can continue with all this intervention, but it has and is, and I'm not yet convinced that it can't indefinitely. Hey Citi was up 5% today, and that's supposed to be news after all the gov has done to prop up that company - it's as if folks are going back to normal, bidding up and trading paper assets, assets that now the gov is backstopping.

For everyone talking about how the "bond holders will revolt" and the "dollar will crash" consider:
--The Fed and Treasury have committed >$8Trillion (that's newly "printed" money")
-- Obama admits that discal deficits will by in the Trillions of $ for years to come
-- the cost to borrow $ is essential zero

Yet, we have a rally in Treasuries and a rally in the $. I know the argument that everyone is deleveraging and needs dollars to do so, but consider what happens when the $ becomes a primary vehicle of a new carry trade. Sure the yen was weak, but never really crashed even though rates to borrow have been near zero for a good long time.

I'm tempted to believe that if the Fed sets expectations as its been doing, a few hundred billion for this and for that, essentially greasing every market that ain't moving fast enough, it can continue "gently" increasing its balance sheet gradually, and system will continue, in a new and "improved" casino.:confused:

[Chris Coles]

Re: Minutes of Federal Open Market Committee

Monetization of MBS means that the folks with mortgages are in debt to the Federal Reserve. The Fed could then forgive the debt, but as I understand it, the initial step of monetization itself just means the Fed creates reserves to buy the MBS from banks, funds, and other institutions that hold them. This doesn't wipe-out mortgage debt in and of itself, but leaves the Fed in control of it.

So, I agree that if the Fed monetizes MBS and then has a great big bonfire, that does indeed wipe out the debt. However, if they are simply going for nominal price stability by one of the mechanisms I outlined above, with the intention of bringing real prices to equilibrium through inflation rather than nominal price declines, they will have a need for new credit creation so that people can refinance or take out new mortgages at low interest rates. I think there may be a problem with this nominal price stability scenario because sustained credit creation might be required to keep nominal prices up, and once inflation is felt, the Fed might find it difficult to keep its game going. But maybe it wouldn't need to. Maybe inflation itself would help support nominal asset prices, and replace the need for credit creation for this purpose. I don't know.

If the CDS are so unstable that the entire system is going to crash without any outside influence. BUT, the system was stable until the moment we all discovered the CDS problem, then why not simply exchange every CDS for dollar bills? The dollars are already there, in the system. You would not be adding any new as they already exist, as CDS. The simplest may well be the only solution to the overall problem.

No new money, it already exists in reality as toxic obligations between the various parties. Simply exchange the toxic paper for real money and then take the consequences, which are never going to be worse than what we have today.

The above quote taken from "Re: Lessons from Japan: The Devil's in the Details Part I - Asset price deflation versus general pri"

Perhaps the FED listens to itulip and sees the sense in what we say..

[stockman]

Re: Minutes of Federal Open Market Committee

Seems the FED is following Fisher's script-

"...it is always possible to stop or prevent such a depression simply by reflating the price level up to the average level at which outstanding debts were contracted by existing debtors and assumed by existing creditors, and then maintaining that level unchanged."

"If the debt-deflation theory of great depressions is correct, the question of controlling the price level assumes a new importance; and those in the drivers' seats- the Federal Reserve Board and the Secretary of the Treasury..."

-Irving Fisher Debt Deflation Theory

http://fraser.stlouisfed.org/docs/MeltzerPDFs/fisdeb33.pdf



But is the lack of confidence demonstrated by the lenders-to-the-lender of last resort a complication?

Setser Running to Treasuries.png

http://blogs.cfr.org/setser/2009/01/05/central-banks-arent-always-a-stabilizing-presence-in-the-market/#more-4350




Also wondering how much difference it made in 1933 (when FDR reflation campaign started) that the asset price deflation had already wiped out all the fluff of the bubble period- stocks down 90%? According to Shiller data PE10 at about 5.5x at 1932 lows. Now at 15x doesn't strike one as a comparable bargain. Home prices remain at high historic levels relative to inflation as well. Should you try to inflate the value of an asset which is NOT historically cheap to start with? Back to Fisher "...reflating the price level up to the average level at which outstanding debts were contracted by existing debtors" IF the average price of the collateral asset was clearly inflated (bubble values) would you want (or be required) to reflate back to that level???

Shiller PE 10 010409.jpg

ShillerRealHomePrice010509.jpg


Shiller/Yale data at: http://www.econ.yale.edu/~shiller/data.htm