The Federal Reserve's decision last month to buy Treasury bonds with cash gained from maturing mortgage securities represents a risky strategy, says former Fed Gov. Frederic Mishkin.
Mishkin, now a professor at Columbia University Business School, told CNBC that the move creates interest-rate risk that could produce losses for the central bank’s balance sheet.
A strong exit strategy should go along with The Fed’s Treasury acquisitions, expected to total about $500 billion, he told CNBC.
The purchases — part of the Fed’s quantitative-easing program — are designed to keep the central bank’s security holdings from dipping below the current level of $2.05 trillion.
"When you hold a lot of long-term debt on your balance sheet, you're now exposed to a lot of interest-rate risks," Mishkin said.
"All of a sudden you could be booking losses. Think about the screams in Congress about all of this."
And Fed Chairman Ben Bernanke said in a speech last month that the Fed will look to buy more securities if the economy continues to falter.
Bernanke said the Fed basically has four options:
• More purchases of government securities;
• Announcements that it will keep interest rates near zero even longer than investors currently expect;
• A reduction of the interest rate it pays on excess bank reserves;
• An increase in its inflation target.
He pretty much rejected the final two ideas, and said the first one is most likely.
But Mishkin is worried about that strategy, calling it a "remarkable shift" and pointing to the need for long-term planning.
"It doesn't mean we should rule out large-scale asset purchases," he said. "It just means the threshold should be very high, and if they're going to do it, they better have a commitment to a long-run strategy to shrink that balance sheet."
Mishkin says the Fed’s $1.75 trillion of securities purchases that ended earlier this year were justified.
"The large-scale asset purchases, the expansion of the balance sheet, were exactly the right thing to do during the depths of the crisis,” he said.
“It's not as clear that they're as effective at this current juncture."
Others agree with Mishkin.
“The current backdrop for quantitative easing is very different to that of 2009, with many of the other positive drivers during that time not being present in the current environment,” Colm O’Shea, head of hedge fund COMAC Capital, wrote in a letter to investors obtained by Bloomberg.
“It is, therefore, a genuine risk that another sizeable asset purchase/quantitative easing program will have a limited impact on growth.”
© 2017 Newsmax Finance. All rights reserved.