Fed Monetary Stimulus Exit: A Blueprint

Fed octopus

The Fed will hold roughly $1.5 trillion in MBS or 30% of the total market by the time their planned buying is over. After pumping the system with trillions in liquidity one of the most common concerns is how the Fed makes an eventual exit. How do they expect to divest these non-standardized relatively illiquid securities without throwing the market into turmoil? Enter Policy Innovation Memorandum No. 30 by Benn Steil:

The Fed should sell its MBS portfolio to the Treasury at face value in exchange for an actuarially equivalent amount of Treasury securities, newly issued for the purpose of facilitating the swap. The maturity of these new Treasury securities could be set either to match the expected maturity of the Fed’s MBS portfolio or to allow them to roll off at the same pace as the Fed expects it will wish to contract its balance sheet (each approach has its own technical merits). The transaction would be neutral for the size of the Fed’s balance sheet; only the composition would change.

There is a clear precedent for the Treasury doing this. The Housing and Economic Recovery Act of 2008 (HERA) gave the Treasury the authority to purchase MBS guaranteed by Fannie Mae and Freddie Mac. The Treasury started buying MBS in October 2008, stopping in December 2009 when the face value of its holdings reached $192 billion. The effect of these transactions was to transfer riskier securities from the private sector to the public sector.

In the case of the proposed Fed-Treasury securities swap, however, there is no such transfer of risk from the private sector to the public—one arm of government is merely swapping securities with another. The overall financial risk to the government as a whole remains unchanged.

Click over and read the entire article. For those who follow along, the Council on Foreign Relations is an extremely influential organization.  Policy ideas floated by them have an unusually high probability of gaining traction.

Policy Innovation Memorandum No. 30 Exiting from Monetary Stimulus: A Better Plan for the Fed (CFR)

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