Bernanke Bid to Lift Housing Scuttled by Rising Rates

Lots of talk about spiking interest rates and how the Fed has "failed," the return of the "bond market vigilantes," etc.

All of this talk is based on misunderstanding the Fed's motives.

I defer to Warren Mosler on this one, from an email that I received. Please read below:

When risky assets are rallying and ‘flight-to-safety assets’ (i.e. Treasuries) are selling-off they don’t care. When private borrowing rates (especially mortgages) are selling-off and so are equities, they do care. In light of the still-fragile state of the economy in general, and housing in particular, question becomes, do they wait until the late June meeting to ramp up security purchases or not if this trend continues? My guess they will try to signal they will do so in June in upcoming speeches, and if that fails, increase the pace before the meeting. From last FOMC meeting statement: As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve will buy up to $300 billion of Treasury securities by autumn. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is facilitating the extension of credit to households and businesses and supporting the functioning of financial markets through a range of liquidity programs. The Committee will continue to carefully monitor the size and composition of the Federal Reserve's balance sheet in light of financial and economic developments. Also, from recent Kohn speech on P&L sensitivity of Fed purchases: Holding such a large portfolio of long-term assets does expose the Federal Reserve, and thus the taxpayer, to potential losses as short-term interest rates rise. We could end up financing our holdings of some low-yielding long-term assets with more expensive short-term liabilities or, we might have to sell some of these assets at a loss as long-term rates rise. But in gauging the potential cost to taxpayers associated with future interest rate movements, several considerations are important to keep in mind. First, some of the Treasury and GSE debt that we are acquiring will run off over the next few years without any need for outright sales, as will some of the MBS as individuals sell or refinance their homes. Second, the yield curve currently has a steep upward slope. Accordingly, we are now earning an abnormally high net rate of return by funding our acquisition of long-term assets with almost zero-cost excess reserves--and this relative yield relationship is likely to last for some time. Thus, in judging the potential budget cost over time, any possible future interest-rate-related losses need to be balanced against the current elevated level of our net interest income. Third, our purchases of long-term securities are boosting economic activity and, in the process, increasing government tax receipts relative to what they would have been in the absence of such purchases.6 All in all, although we have now taken more interest rate risk onto our balance sheet than usual (at a time when the private sector wants to avoid this risk), that action may boost, rather than reduce, the cumulative net income of the Treasury.

In other words, if stocks start falling again and the economy remains weak, the bond market vigilantes will get their heads handed to them by the Fed. On the other hand if economic activity picks up and stocks are rising, the Fed will let the bond bears have a field day.