New refinancing activity and additional sales could help to strengthen the economic recovery
Congress is gridlocked, consumers are pessimistic, and firms are barely hiring. To speed this recovery up -- or to prevent a double dip -- it might be up to the Federal Reserve. Last week it announced its latest attempt to revitalize the economy. Its chief target appears to be the still anemic housing market. Will the new policies work?
The Fed's Plan
The central bank will take two different actions meant to jumpstart the economy. First, there's "Operation Twist." The Fed will attempt to push down long-term interest rates by purchasing $400 billion in Treasury securities with six to 30 year terms. The program will last for nine months -- through June 2012.
But here's the clever part: the Fed will sell shorter-dated Treasuries in exchange for bank reserves. This will prevent the Fed from having to expand its balance sheet to purchase longer-term Treasury securities. The relative increase in short term rates should be small, since short-term Treasuries are in high demand and the Fed is keeping other short-term rates low through its other policies.
The Fed announced another policy change as well. It has been reinvesting its maturing principal in additional Treasury securities. The central bank will refine that approach by investing maturing principal from its agency bonds and mortgage-backed securities in additional agency mortgage-backed securities. In this way, it will keep the size of its mortgage securities exposure level. But more importantly, this action will also increase the demand for mortgage-backed securities, which should push down mortgage interest rates.