Mark Thoma directs us to a Washington Post article detailing the slow start-up of the Federal Reserve’s much discussed but little used TALF program. At this juncture, a critical constraint appears to be counterparty risk – no one trusts the US government to hold parties to their contractual obligations:
Sources involved in the program said private investors have been reluctant to work with the government, which they view as an unreliable business partner. … There are restrictions on the business activities of participants in the program. … But perhaps more significant … is a fear that the government could retroactively change the terms, exacting new limits on what investors can pay their executives, for example, or trying to claw back profits that firms make in the program. …
Perhaps TALF will gain traction in the months ahead. For now, however, I imagine that no amount of lipstick is able to conceal what must be official disappointment with the program. The question on my mind is will slow take up on TALF induce the Federal Reserve to step up its purchases of mortgage assets and longer term Treasuries. From the last Fed minutes:
Members expressed a range of views as to the preferred size of the increase in purchases. Several members felt that the significant deterioration in the economic outlook merited a very substantial increase in purchases of longer-term assets. In contrast, the potential for a large increase over time in the size of the balance sheet from the TALF program was seen as supporting a more modest, though still substantial, increase in asset purchases.
It looks like the expected success of TALF was a reason for moderating the size of the balance sheet expansion via longer term assets. It would stand to reason, all else equal, that TALF’s slow start would trigger the Fed to step up purchases of other assets.
Also, one would think the Fed would take note that expanding their purchases of longer term assets has been a relatively successful policy, especially if the goal was to pull mortgage and Treasury rates lower. To be sure, the ultimate impact on spending in the near term is likely to be muted – the benefits of lower mortgage rates are limited to households that are not credit impaired or underwater on their homes, and we are not likely to see much equity withdrawal this time around. But lower rates are triggering a wave of refinancings, which will lessen the cash drain of maintaining household balance sheets, and free up some additional spending power. Overall, however, the Fed will be wary that the benefits of their last policy expansion will wane if Treasury rates pull above 3%, and thus will be induced to expand purchases of those assets, trying to offset the impact of the massive supply issuing forth from Treasury.
It is interesting that a relatively simply policy – one that does not require and army of lawyers and financial managers – has been much more successful and quick to execute than the exceedingly complex TALF program. If policymakers were not so blinded by the fetish of finance, they would see this as an example of the time honored KISS principle.
Another policy change to be watching for – when will the Fed commit to a quantitative goal for a sustained rate of expansion in the balance sheet? From Federal Reserve Vice-Chair Donald Kohn:
In gauging the effects of market interventions in the current crisis, one approach is to look to the size of increases in the quantity of reserves and money to judge whether sufficient liquidity is being provided to forestall deflation and support a turnaround in growth–an approach often known as quantitative easing. The linkages between reserves and money and between either reserves or money and nominal spending are highly variable and not especially reliable under normal circumstances. And the relationships among these variables become even more tenuous when so many short-term interest rates are pinned near zero and monetary and some nonmonetary assets are near-perfect substitutes. In our approach to policy, the amount of reserves has been a result of our market interventions rather than a goal in itself. And, depending on the circumstances, declines in reserves may indicate that markets are improving, not that policy is effectively tightening or failing to lean against weaker demand. Still, we on the Federal Open Market Committee (FOMC) recognize that high levels of Federal Reserve assets and resulting reserves are likely to be essential to fostering recovery, and we have discussed whether some explicit objectives for growth in the size of our balance sheet or for the quantity of the monetary base or reserves would provide some assurance that policy is pointed in the right direction.
What conditions could force the Fed from “credit” easing to “quantitative” easing, the latter being explicit policy guides for monetary expansion? The Fed could seek to force a firmer lid on longer-term Treasury rates. Another is that the Fed believes that setting a quantitative target is necessary to keep inflation expectations anchored in the face of the deflationary potential of persistently wide output gaps. Alternatively, the Fed could choose to forgo quantitative targets as they evaluate the durability of the green shoots emerging from the economic wasteland.
Bottom line: The challenges of setting in motion the complex TALF program suggests that the Fed will step up purchases of longer term Treasuries. The next policy line to cross is the formation of explicit policy objectives for the growth of a monetary aggregate. I would be looking for language in Fedspeak that points in that direction.