And this week, indeed, the Fed, together with the Treasury, started to implement some of the “crazier” policy actions that we discussed last week: a) outright purchases of agency debt and MBS to the tune of a whopping $600 billion; b) another $200 billion of loans to backstop the consumer and small business credit markets (credit cards, auto loans, student loans, small business loans); c) an effective policy of aggressive quantitative easing as the balance sheet of the Fed – already grown from $800 billion to over $2 trillion – will be expanded further as most of the new bailout actions and new programs will be financed via injections of liquidity rather than issuance of public debt.
Effectively the Fed Funds rate has been abandoned as a tool of monetary policy as we are already effectively at the zero-bound for the policy rate that signals a liquidity trap; and the Fed is now relying on massive quantitative easing and direct purchases of private sector short term and long term debts to try to aggressively push down short term and long term market rates.
No wonder that, after announcing $600 billion of purchases of agency debt and MBS the rate on 30 year mortgage rates has fallen overnite by 75bps. Even that radical fall in mortgage rates – the largest daily move in decades – will be of small comfort to debt burdened households as only those who qualify for refinancing will be able to do that and the total average monthly savings on mortgage debt service would amount to a modest $150.
Desperate times and desperate economic news require desperate policy actions, even more desperate than any “desperate housewife” could dream of. The Treasury will be issuing in the next two years about $2 trillion of additional debt (on top of having to refinance and rollover another $1 trillion of maturing debt) while the Fed/Treasury/FDIC are taking on a massive amount of credit risk via outright bailouts and guarantees (TAF, TSLF, PDCF, ABCPFFFMLM, TALF, TARP, Bear Stears, AIG, Citigroup, TALF and another half a dozen new facilities and programs). These policies – however partially necessary – will eventually leads to much higher real interest rates on the public debt and weaken the US dollar once this tsunami of implicit and explicit public liabilities and monetary debt driven by rising twin fiscal and current account deficits will hit a world where the global supply of savings is shrinking – as most countries moves to fiscal deficits thus reducing global savings – and foreign investors start to ponder the long term sustainability of the US domestic and external liabilities.
The only question I have is: How hard is the landing going to be?