Encima Global president and former Reagan adviser David Malpass says “Operation Twist” — the Federal Reserve's expected bond-buying program — creates an obvious conflict of interest.
“More Fed purchases would hurt savers by lowering, for example, CD yields, add to market uncertainty, further distort short-term credit markets, and worsen the Fed's conflict of interest in setting interest rates, because its bond portfolio will lose value if it raises rates,” Malpass writes in The Wall Street Journal.
“More fundamentally, the Fed should not be in the business of dangling bond purchases in front of world markets,” says Malpass.
“Since the financial crisis, the Fed has been transforming itself from a monetary policy agency into a market-intervention shop, helping explain the thirst for gold, which has shot up to more than $1,800 per ounce.”
Instead, the Fed should instead be using its considerable energy and expertise to provide sound money, and using its bully pulpit to encourage federal spending restraint and regulatory reform in line with its full-employment mandate, Malpass says.
To try to flatten the yield curve, the Fed wants to buy more long-maturity bonds and finance them by selling some of its shorter-term bonds (Operation Twist) or by further increasing the $1.6 trillion in short-term deposits it holds for commercial banks — in other words, more quantitative easing, Malpass explains.
"Either way, borrowing short and lending long is risky financial behavior. It exposes the taxpayer to interest rate risk — since the Fed's bond holdings will lose value if interest rates go up," says Malpass.
"Fed bond purchases shorten the maturity of the national debt. When it buys bonds, the Fed negates the Treasury Department's bond issuance, the goal of which should be to put longer-maturity debt into the global private sector while bond yields are low."
Long-maturity Treasury bonds protect taxpayers from higher interest costs in the event that interest rates have to rise in the future, notes Malpass — but this won't happen if the Fed just buys the bonds back and holds them on its own balance sheet.
"By my estimates, the Fed's Treasury bond purchases in 2008-2011 shortened the average maturity of the national debt to four years from five, not counting the further shortening from the Fed's purchases of mortgage bonds," Malpass says.
The bond market will cheer if the Fed buys more bonds because it loves a big buyer who doesn't care about price, especially when purchases are announced in advance, giving markets an opportunity to buy first, and Washington would be pleased because with the deficit running over $1 trillion per year, Treasury has to move a lot of them.
However, Malpass points out, our central bank has already bought nearly $2 trillion in longer-term bonds, a massive intervention in markets, with no constructive results.
Meanwhile, in an unusual move, Republican leaders of the House and Senate are urging Federal Reserve policymakers against taking further steps to lower interest rates, the Associated Press reported.
Monday, on the eve of the Fed's two-day policy meeting, the leaders sent a letter to Chairman Ben Bernanke warning that the Fed's policies could harm an already weak U.S. economy.
The letter was signed by Senate Republican Leader Mitch McConnell of Kentucky, Senate Republican Whip Jon Kyl of Arizona, House Speaker John Boehner of Ohio and House Majority Leader Eric Cantor of Virginia.
The letter followed criticism from several Republican presidential candidates that the Fed's efforts to boost growth have already raised the risk of high inflation.
"The American people have reason to be skeptical of the Federal Reserve vastly increasing its role in the economy," the lawmakers wrote.
It is rare for lawmakers to try to sway policy at the Fed, which operates independently of Congress and the White House. But the letter was sent at a time when Bernanke, a Republican, has faced growing criticism from members of his own party, the AP reported.
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