Sunday, February 21, 2010

Normalization and Transfer Exiting

In our last post in which we discussed the Discount Rate, we indicated this was not monetary tightening but just another step in the Fed's announced actions to normalize liquidity and lending programs.  Econobrowser has succinctly summarized the probable meaning of the 25 basis point hike in the Discount Rate with no hike in the Fed Funds Rate, which is unlikely to happen anytime soon.  I do know if there is any significance in the fact the last time the Fed raised the Discount Rate after 24 months of unemployment was 1931; this could be just interesting rather than profound.

In discussing the Fed exit strategy in our last post, I asked who would buy the Mortgages Backed Assets on the balance sheet of the Fed once the Fed is ready to sell.  John Hussman in his last Monday commentary suggested the possible scenario that the US Treasury could issue another $1.5 trillion in debt over the next few years (matching the amount of purchases on the Fed balance sheet) and periodically transfer the proceeds to Fannie May and Freddie Mac to cover continuing balance sheet losses enabling Fannie and Freddie to "redeem" the mortgage securities from the Fed without the need for liquidation or any other unwinding operation.  This would make the securities disappear from the Fed and reappear as an obligation of the American people while protecting the lenders.

This would not be right, but it is almost beautiful in its logical plausibility.

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