Thursday, March 25, 2010
Top Fed official doesn't understand monetary operations
Yesterday (3/24) I was on Fox and we had Kansas City Fed President Thomas Hoenig on and he was talking about the need to reverse the "extraordinary measures" that the Fed has taken since the crisis because it raises the potential for huge inflation.
Specifically, Hoenig spoke with great concern about how the Fed must sell off its huge portfolio of mortgage backed securities.
I sat there listening to this guy, utterly dumbfounded that he does not even understand basic monetary operations.
From his comments one could surmise that Hoenig believed the purchase of MBS was nothing more than some kind of irresponsible speculation--a position the Fed took for monetary gain--which it now has to carefully sell in order to "book" the profits.
He should know that the Fed's purchase of mortgage backed securities was the way by which it sets interest rates. To get mortgage rates down, the Fed needed to purchase MBS and that's what it did. It was not a "trade."
The Fed's purchase of securities--whether they be MBS or Treasuries or anything--is always the mechanism it uses to manipulate reserve balances higher and that puts downward pressure on rates.
"Exiting" is achieved by simply doing nothing, because the Treasury's ongoing sales of securities functions to drain reserves automatically. In the last six months the Treasury has sold nearly $4 trillion of securities. That is nearly four times the current level of system reserves!
It is very disturbing that such a high level monetary official is so lacking in knowledge when it comes to basic operational realities of the Fed and government finance.