Magazine article American Banker

Fed Seeks Other Bonds for Monetary Policy

Magazine article American Banker

Fed Seeks Other Bonds for Monetary Policy

Article excerpt

With the supply of Treasury bonds declining, the Federal Reserve is considering what other kinds of securities it might use to conduct monetary policy, but bond market experts say agency debt is its only realistic option under current law. The Fed regulates the economy by controlling the money supply. One way it injects liquidity or drains it from the economy is by buying or selling securities, most of which are Treasuries. But the supply of Treasury securities is dwindling because of buybacks prompted by budget surpluses. In a January study, the Congressional Budget Office projected that Treasury debt would fall to $941 billion by the end of 2010 from a projected $3.5 trillion at yearend 2000. As Treasuries have become scarcer, the Fed has begun using agency debt and mortgage-backed securities guaranteed by the two major government-sponsored enterprises in its open-market operations. Some Wall Street sources speculate that agency debt will eventually eclipse Treasury supply. In the fourth quarter of 1999, the combined outstanding debt of the government-sponsored enterprises was $3.9 trillion; outstanding Treasury obligations totaled $3.65 trillion. "It's a point of distinction," said Peter Horvath, director of debt marketing at Freddie Mac. Indeed, the use of agency bonds in open-market operations would seem to support the case for Fannie Mae and Freddie Mac debt as a new benchmark for the board markets as Treasury volume shrinks. However, minutes from the Federal Open Market Committee's March meeting released last week said the Fed supports a broad study of "alternative asset classes," which could be used to regulate monetary policy in the face of "paydowns of marketable federal debt." Though the committee voted to continue using agency mortgage-backed securities to regulate monetary policy, the minutes specified that "the requested temporary expansion of authority" into mortgage-backed securities "should not be read as indicating in any way how the committee might ultimately choose to allocate the portfolio. …

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