With economy up, Fed may unload some assets
WASHINGTON — Federal Reserve officials took bold steps to battle the financial crisis, none more audacious than purchasing trillions of dollars in bonds in an unprecedented and politically charged attempt to boost economic growth.
Now, with the economy healthier, the Fed is preparing to scale back its hoard of about $4.5 trillion in assets.
Those holdings of mostly Treasury bonds and mortgage-backed securities are more than quadruple what they were before the crisis, and reducing them is another risky move that could affect mortgage rates, consumer prices, bank lending, stock values and federal government borrowing.
But there’s also risk to standing pat. The central bank could suffer losses on the bonds if it holds them too long and interest rates rise. Holding a lot of assets could also make it harder to buy more if that’s needed to fight a future recession.
So Fed policymakers plan to start trimming their holdings this year. They hope to do it gradually and seamlessly. “We think this is a workable plan and it will be ... like watching paint dry,” Fed Chair Janet Yellen said last month.
That wasn’t the case in 2013. Then-Fed Chairman Ben Bernanke’s suggestion that the central bank would begin a tapering of its ongoing asset purchases surprised investors. His comments caused stock prices to drop and bond yields to spike.
Fed officials learned from that experience. This time, they have carefully signaled their plans in recent weeks and have promised to proceed cautiously to avoid spooking investors and harming the recovery as well as their own credibility.
The 2008 financial crisis supercharged the recession, threatening to plunge the nation into another Great Depression. The Fed already was well underway in lowering its key short-term rate close to zero. But the economy remained in deep trouble.
So Fed officials tried a tactic pioneered by Japan’s central bank in the early 2000s: large-scale asset purchases known as quantitative easing. Buying government bonds and mortgage-backed securities tends to push down mortgage and other long-term interest rates. Mortgage rates are tied to the value of Treasury bonds, and the higher demand for mortgage-backed securities helps push rates lower because the return on those securities doesn’t have to be as large to attract investors. Those falling rates encourage spending and investing over saving.
The move also increases the money supply because a central bank buys the bonds by electronically increasing the reserves it holds of the commercial bank from which the purchase was made. So, in effect, the Fed prints new money, which can be borrowed and spent.
Fed policymakers launched three rounds of quantitative easing, purchasing Treasury bonds and mortgage-backed securities. The effort “significantly lowered long-term interest rates which helped support the housing market and the broader economy,” said Mark Zandi, chief economist at Moody’s Analytics.
Other analysts said the Fed’s stimulus plan helped only marginally in stimulating the economy and wasn’t worth the risks.
“Normally that kind of asset acquisition would have been expected to lead to a vast increase in spending,” said George Selgin, director of the Center for Monetary and Financial Alternatives at the Cato Institute, a libertarian think tank. “It didn’t stimulate spending very much at all.”
There’s one thing nobody disputes: The asset purchases swelled the Fed’s balance sheet to unprecedented levels.