The Federal Reserve is overstepping its boundaries and distorting credit markets with its massive purchases of mortgage bonds, say Richmond Federal Reserve Bank President Jeffrey Lacker and John Weinberg, the bank's research director.
"Central bank legitimacy will wane without boundaries on tools used for credit-market intervention," they write in The Wall Street Journal
Since 2009 the Fed has purchased $1.7 trillion of mortgage-backed securities (MBS) underwritten by Fannie Mae and Freddie Mac.
"The Fed's MBS holdings go well beyond what is required to conduct monetary policy, even with interest rates near zero," Lacker and Weinberg argue.
And "when the central bank buys private assets, it can tilt the playing field toward some borrowers at the expense of others, affecting the allocation of credit."
The Fed's MBS holdings favor mortgage holders by forcing mortgage rates down, the duo notes.
"This increases the interest rates faced by other borrowers. It is as if the Fed has provided off-budget funding for home-mortgage borrowers, financed by selling U.S. Treasury debt to the public," they maintain.
"Such interference in the allocation of credit is an inappropriate use of the central bank's asset portfolio. It is not necessary for conducting monetary policy, and it involves distributional choices that should be made through the democratic process and carried out by fiscal authorities, not at the discretion of an independent central bank."
Meanwhile, former Fed Chairman Alan Greenspan warns that the central bank's eventual interest-rate hikes could lead to volatility in long-term interest rates.
"Remember, central banks do not and cannot control longer-term rates, which are fundamentally based on discount factors of expected earnings," he tells CNBC
The Fed has kept its federal funds rate target at a record low of zero to 0.25 percent since December 2008. Many economists forecast the central bank will begin increasing rates around the middle of 2015.
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