by Peter Miller
It was less than ten years ago the country was on the verge of financial collapse. In response, the government loaned out almost $700 billion to save Wall Street while the Federal Reserve cut interest rates to the bone.
The Fed also did something else which was crucial; under its Quantitative Easing (QE) program, it agreed to purchase mortgage-backed securities at a time when not too many other buyers were interested. In effect, the Fed created a sure way for lenders to convert mortgages into cash by its willingness to purchase mortgage-backed securities. With less lender risk, mortgage rates were held down.
Over time, the Fed purchased some $4.5 trillion in mortgage-backed and treasury securities, paper it may now be willing to sell off according to discussions revealed in the March meeting of its Federal Open Market Committee
. If such sales come about, it would represent the end of an era, the downsizing of the Fed's vast asset portfolio.
The Fed, of course, has not said outright what it will do. Instead the minutes hint at the course it might take if certain economic goals are achieved. At the same time it has also reserved the right to “restart reinvestments if the economy encountered significant adverse shocks,” thus giving it the ability to say both that it may sell off securities or it may buy more.
Such double-talk follows an historic pattern at the Fed. As former Fed Chairman Alan Greenspan once explained, “I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I’ve said.”
Debt and Clutter
If you look at the worldwide debt market you can see two competing trends. On one hand the world is adrift in a sea of debt, some $215 trillion according to The Telegraph
, an amount, which increased $70 trillion during the past decade. On the other hand -- according to BlackRock
-- the world has some $50 trillion in investible funds sitting on the sidelines as of October.
These numbers very much impact any effort by the Fed to off-load massive amounts of debt. Clearly there is money out there which can absorb the Fed's $4.5 trillion in mortgage-backed and treasury securities. At the same time, current investments have not attracted a substantial amount of free cash because they somehow offer the “wrong” combination of risk and reward.
Will the Fed find ready investors for its stash of financial securities?
Given so much debt worldwide the Fed will have to do something to make its offerings stand out. Happily, it has a number of favorable values, which are unique to the mortgage-backed securities it wishes to sell.
First, the US housing market is coming back: the National Association of Realtors (NAR) said in February that existing home values have enjoyed 60 consecutive months
of year-over-year gains. Second, a lot of cash worldwide – perhaps $50 trillion
– produces a return of less than .5 percent. Third, a huge chunk of that low-return debt – about $13 trillion
as of last summer – generates negative returns. Fourth, this might be the right time for the Fed to sell.
Back in 2008, Bill Gross with Janus Capital Group
said, “central banks were in a position to drastically lower yields and buy trillions of dollars via Quantitative Easing (QE) to prevent a run on the system. Today, central bank flexibility is not what it was back then. Yields globally are near zero and in many cases, negative. Continuing QE programs by central banks are approaching limits as they buy up more and more existing debt, threatening repo markets and the day to day functioning of financial commerce.”
A New Market
“A sell-off of Fed securities raises a number of questions,” said Rick Sharga, executive vice president at Ten-X.com
, an online real estate marketplace. “How much of the huge portfolio will be sold off? All or a portion? How will the sales be conducted – so much per month, occasional sales, all of the securities, or just a little right sizing by the Fed? And, most critically, what might the impact of be of these sales on the mortgage market?”
And after the mechanics of the sale are worked out then the real question looms ahead: what happens with the proceeds from the sales? Will the Fed somehow hang onto the money or will it be transferred to the Treasury, as now happens with Fed profits, including almost $92 billion
sent to the government in January. A Fed yard sale could substantially lower the federal deficit, a result which no doubt would thrill politicians and taxpayers of all stripes.